Investors have been so conditioned to the goal of 2% inflation rate that it is firmly planted in our mind every time a government agency releases its monthly CPI. What follows is the inevitable speculation about when central banks will cut rates. The March inflation numbers have not done anything to change the conversation about rate cuts. 

March headline inflation released by the BLS is running at 3.5% annualized and core inflation at 3.8%. Another month of disappointing news. Immediately, rate observers conclude that the Fed is no hurry to cut rates. In fact, just last week, the head of JP Morgan opined that rates may have to increase slightly to ward off a resurgence in inflation. A contrarian views? That view aside, it is entirely possible that we just simply cannot cool inflation, unless we agree to raise rates to a level that will guarantee a significant downturn. The results of two years of dramatic rate increases have quelled inflation to a great extent, but not enough to reach that elusive 2% target. Simply put, monetary policy has taken too long, produced insufficient results, all the while real interest rates remain well above zero and discourage economic expansion.

Today’s announcement by the Bank of Canada to leave its policy rate unchanged at 5% reflects its wait and see attitude on inflation. The first quarter of 2024 Canada’s annualized inflation rate was 2.8%, not low enough for the Bank to shift directions The Governor would like to have proof positive that there is momentum towards reaching the 2% target.  He does not seem to be in rush to start to cut rates.

US CPI  12-month rate of change

Economists revert to no end of reasons why, in this or any month, inflation continues to remain above target. Quirkiness in calculating the Owner’s Equivalent Rent (OER) is often trotted out as a reason for a pop in that important component. Higher mortgage rates, following adjustments in the longer-term interest rates, is another explanation put forth. In the non-housing sector, supply chain issues are a monthly favourite, blaming delays in overseas shipments or domestic transportation interruptions as one of the culprits. Finally, the all-important service sector seems to march to a different tune as prices rise as a matter of everyday activity. The readers can choose what explanation suits them. 

So, let's suppose for a moment that inflation just never comes down to the 2%, no matter how hard a central banker works. What can be done?

• Continue on the current path. When push comes to shove, central bankers will argue that patience is required, that they are on the right path and it takes time to cool inflation; stay the course, seems to be the Fed’s and the Bank of Canada’s preferred option;
• Move the goal posts. To many monetary authorities, this is probably a heresy. Such a change is nigh impossible given the deeply embedded thinking that 2% only can be considered. Anything figure higher is tantamount to defeat. Yet, there is no theoretical basis for adopting the 2% measure, rather it is a convention and conventions should not be considered as sacred.

Raise rates until the job is done. However, economic growth is far from solid and any further hike in rates will mostly kill growth without any assurance that inflation will tumble. 

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