Are Central Bankers Relaxing the 2% Inflation Target in Favour of Growth?

Last week, the Bank of Japan abandoned its earlier pledge to hit the 2% inflation target by 2019, confessing that its monetary policy is not affecting inflation as once thought. The BOJ will continue to aim for 2%, but the timetable has been scrapped. Inflation for March came in at 0.5% over the past 12 months and there appears to be no momentum that would carry the rate to its 2% target by 2019. The BOJ made it clear that “the year-to-year rate of change in the consumer price index has continued to show relatively weak developments.” Japan continues to experience labor shortages and unemployment running at 2.5%. The risk to growth now is the focus of monetary policy. How far behind are other countries in adopting a more relaxed attitude towards inflation targets?

The Federal Reserve is clearly out in front, given the pronouncements by several governors that more rate hikes are in the cards for 2018.Yet, as data roll in from various segments, the 2% target has already been exceeded. Year-over-year the CPI registered 2.4% in March and businesses have voiced concern over rising input prices. Some of the pressure comes from temporary surges in energy prices, while other pressures related to selective labor shortages. However, growth is at risk from tariff wars, higher oil prices, consumer exhaustion and a general slowdown in the major trading nations. It remains to be seen whether the Fed sticks to its guns, especially if growth weakens.

The Bank of England was handed a real surprise last week when GDP for the most recent quarter barely advanced. After raising the bank rate last November, the BoE warned that more increases were on their way and that inflation had to be brought under control. Inflation for March clocked in at 2.5%, signaling the need to ratchet up rates, that is until the 2018 first quarter GDP numbers were released. Moreover, the weakness was not related to temporary factors. Now, the BoE is backing away from specifying a path for future rate hikes. Concerns over Brexit, domestic growth and protectionism now dominate policymakers’ time and energy.

The Bank of Canada experienced a similar change of heart or mind. After increasing its policy rate three times between July 2017 and October 2018, observers were starting to chart a path of rate increases steadily for the balance of the year. Year-over-year consumer prices for March came in at 2.3%. Although this is within the Bank’s inflation target range of 1-3%, it does represent some heating up. Yet, the Bank of Canada has made it known that some of the movement in consumer prices can be traced directly to temporary factors, e.g. oil price spikes and a one-time jump in the minimum wage. Governor Poloz in recent statements seems to be in no hurry to increase the bank rate. He is worried about the uncertainties with U.S. trade policies and with the recent slowdown in output. Again, inflation seems to be pushed to one of the back burners.

We should not expect that the central bankers will jettison the 2% inflation target since it is the mainstay of its policy decisions. However, the target may be breached in the hope of maintaining economic growth. Investors should not focus too heavily on the inflation target at this time.