Over the top

"Things should start getting interesting right about now". (Bob Dylan, "Mississippi")

Things are certainly about to get interesting for the Bank of Canada and its Governor, Stephen Poloz.  Statistics Canada just reported that headline inflation rose to 2.2 percent year-on-year in February, the first time it has moved above the 2 percent target since 2014.  All eight major components of the index have risen over the past year, but the biggest culprit has been the price of gasoline, up more than 12 percent on a year-over-year basis.  CPI ex gasoline is up a slightly less threatening 1.8 percent.

There's more.  The Bank's famously obscure "preferred measures" of inflation have been edging up towards 2 percent for several months now. In February two of the three indices (CPI-median and CPI-trim) edged above the target, with both standing at 2.1 percent.  If these really are the key indicators the Bank looks at when it makes its policy decisions, then it is hard to see how additional tightening measures can be delayed for very long.

There is little reason to think that the gradual rise in year-on-year inflation will stall any time soon.  The Bank has been warning for almost a year now that the economy is operating close to full capacity, which must inevitably translate into cost and price pressures at some point.  The protectionist measures that now seem to be coming out of Washington on almost a daily basis will inevitably push prices higher south of the border, but because of the close integration of the two economies, that will also spill over into Canada.  Lastly, the Canadian dollar seems to be on shaky ground, and any further weakness in the exchange rate would add further to upward pressure on Canadian prices, not least for gasoline.

Governor Poloz has been preaching caution about the rate outlook, even musing at one point that there might be no further action by the Bank this year.  Moreover, the Bank's increasingly prominent Senior Deputy Governor, Carolyn Wilkins, has recently spoken of work "still to be done" to ensure financial system stability.  Given the high debt level of Canadian households, rapid rate increases by the Bank could start to put that stability at risk.  Still, if it wants to maintain the credibility of its inflation target -- which it surely must -- the Bank will not be able to ignore the upward trend in CPI for very long.  Best guess: one 25 bp rate hike by mid-year and another in the second half.