No one said the life of a central banker is easy, especially when it is faces a mixed set of economic data. This is the situation facing the Bank of Canada as its formulates rate policy in about two weeks.

On the macro front, the Canadian economy expanded at a very healthy clip of 3.7% (annualized) in the first quarter (Figure 1). Most components within the GDP measure performed well, with the major exception of exports. Overall it was an impressive start to the year. On this GDP scorecard alone, some pundits are calling for the Bank to hike rates before the year is out.

(Click on image to enlarge)

The Bank has only one mandate and that is to provide price stability. The Bank has a target, as measured by the consumer price index (CPI), of 2 %, the midpoint of the control range of 1 to 3 %. Inflation is actually decelerating with the consumer price index dropping to 1.3% in May from 1.6% in April. This most recent  inflation report is consistent with the Bank’s view that “slack in the economy is still translating into inflation that is below our target".

Furthermore, the oil market is suffering from an serious over supply situation as oil prices have dropped to the low $40s. As a consequence, the Canadian dollar is under some pressure and, short of a complete reversal in the oil market, will continue to be in the $ 1.32-1.35 (USD/CD) range.

In addition, there is the weakness in wage growth as employers are able to keep wage increases within range of productivity growth. There is little evidence of any cost- push inflation in Canada.

The whole matter of inflation and growth are wrapped up in the bond market. The yield on 10yr Govt. of Canada bond has dropped nearly 50bps since the beginning of this year and continues to trend downward. Bond investors do not anticipate any uptick in inflation or strong economic growth over the entire range of the yield curve. Should the Bank raise its policy rate, bond investors would most likely push yields down even further, raising the spectre of an inverted yield curve.

It is unlikely that the Bank will shift gears and tighten at its next policy meeting. The weak inflation outlook and uneven growth prospects continue to frame the policy discussion.