Bank of Canada says recent inflation forecast errors due mainly to global shocks

The Bank of Canada on Wednesday said its consistent underestimation of inflation since the spring of last year has been mostly due to global shocks that drove up commodity and energy prices faster than expected.

The central bank again significantly increased its inflation forecasts on Wednesday versus April as it announced a surprise full-percentage-point increase to its overnight interest rate.

The bank said it uses a flat assumption about oil prices over its two- to three-year projection horizon, and that assumption has consistently underestimated oil prices since 2020.

“Commodity price effects alone account for over 40% of the Bank’s total underprediction of inflation,” the central bank said in its quarterly forecast document. “The Russian invasion of Ukraine has driven prices for oil and natural gas even higher.”

The bank said that refinery margins also led to higher-than-expected gasoline prices, and that the correlation between rising oil prices and the appreciation of the dollar “has not held”.

That means the lower import costs that come with a stronger dollar are not helping mitigate rising oil and gas prices as they once did.

Some 20% of the forecast errors were due to an underestimation of supply chain pressures.

“The Bank had expected supply chains to be restored quickly once initial lockdown measures were lifted,” the bank said.

On the domestic side, a sharp rise was the main contributor to the forecasting error, with the faster-than-expected rebound also playing a role. Housing prices have boosted inflation by 1.2 percentage points since the middle of 2021, the bank said.