The most telling element of this morning's Bank of Canada's policy statement may not be so much the words, as where the central bank has chosen to put them.
The statement's paragraph on its inflation outlook, which has resided in the bottom half of the statement for literally years in the bank's eight-times-a-year policy statement, is now at the top. Second paragraph, right after the deeply unsurprising headline news that the bank has maintained its policy interest rate at 1 per cent for the 27th straight time (it last changed in September, 2010).
In the world of central banking, where every word and emphasis matters, this is no meaningless housekeeping by a relatively new brain trust (this is only the fifth statement issued under Governor Stephen Poloz, who took the reins last June). This is a crystal-clear indication that Mr. Poloz and his team has shifted focus to inflation – or, more precisely, the persistent and dangerous lack of inflation. If this point needed additional emphasis, the bank comes back to the inflation issue for a second swipe at the bottom of the statement, leads its quarterly Monetary Policy Review (released at the same time) with a quote from Mr. Poloz on inflation, and begins its Monetary Policy Report summary with a paragraph on inflation.
There's now little doubt that disinflation has become the central bank's biggest fear – supplanting its concerns about household debt as the top threat to Canada's economy.
"Inflation is expected to remain well below target for some time, and therefore the downside risks to inflation have grown in importance," the statement said. "At the same time, risks associated with elevated household imbalances have not materially changed."
In terms of new language added to the statement, the whopper was saved to the very end: "The timing and direction of the next change to the policy rate will depend on how new information influences this balance of risks."
You'll want to emphasize "direction" here. Up until now, the bank's policy statement had never actually said out loud that a rate cut was a possible direction, even though it did effectively move to a neutral policy stance (from its previous stated leaning toward eventual rate hikes) last fall.
In short, the Bank of Canada is setting up market expectations for a rate cut, if necessary, to combat persistently low inflation that continues to flirt with the bottom of the bank's 1-to-3-per-cent target band. (The consumer price index (CPI) inflation rate stood at 0.9 per cent in November, the latest figures available. Core CPI, which excludes the most volatile components, was at 1.1 per cent.)
At the same time, though, the central bank does suggest it sees light at the end of the disinflation tunnel. It said the "fundamental drivers of growth and future inflation appear to be strengthening." It increased its economic growth forecast for 2014 to 2.5 per cent from 2.3 per cent. It still sees inflation returning to the bank's 2-per-cent target by the end of 2015 – taking a bit more of a meandering path to get there, but the finish line hasn't moved back. The bigger concerns seem to surround the nearer-term disinflationary drift, and the need to nip it in the bud before it becomes entrenched in expectations – a time-tested killer of economic growth.
The central bank's message to markets – we're ready to take action if inflation forces our hand – may already be helping its inflation-fighting cause. The Canadian dollar has already been drifting lower as the Bank of Canada's tone has turned increasingly dovish in recent months; this morning's policy statement knocked three-quarters of a cent off the currency, threatening the 90 cents (U.S.) threshold for the first time in nearly four years. The substantial weakening of the currency is itself inflationary, as it will inevitably raise the cost of imported goods for Canadian consumers. By shifting the market's expectations, the Bank of Canada just might be able to reverse the inflation slide without having to use its rate-cut weapon.