Canada seen as unlikely to tamper with inflation target during review

By Randall Palmer and Leah Schnurr

OTTAWA (Reuters) - Canadian financial authorities are unlikely to raise the country's inflation target after a review this year given the risk to the central bank's credibility and widespread support for the existing benchmark, economists say.

The Bank of Canada, which reviews the target every five years, flagged in November that it was researching whether to raise the target above 2 percent, given the difficulties of conducting monetary policy with interest rates near zero.

Governor Stephen Poloz said in February that 2 percent had proven itself in delivering superior outcomes, "so that means it's a pretty high bar to change that and replace it with something else."

Many investors are also wary of another unorthodox move from the central bank after a January rate cut decision that caught nearly everyone off guard.

A decision to raise the target, which must be made jointly with the Department of Finance, is seen as a hard sell politically, given that it would erode savings and purchasing power.

"That's a very difficult communication challenge ... how to communicate to the public that more inflation is better for them," said Emanuella Enenajor, an economist at Bank of America-Merrill Lynch.

Conservative Finance Minister Joe Oliver, asked in New York on Wednesday about raising the target, was non-committal, noting the current target "has served us well, but this review looks forward."

The bank introduced the 2 percent target in the early 1990s after an aggressive campaign to tame inflation in the 1980s came at an enormous cost to output and employment.

For most of the time since 2007, core inflation, which strips out volatile items and is closely watched by the bank, has been below the target, though since August 2014 it has been above 2 percent. Overall inflation has fluctuated more widely but was below the bank's 1 to 3 percent range for part of 2013.

Some economists said that if the 2 percent anchor were cut loose, many Canadians and international investors might question whether the central bank would stop at 3 percent.

The lower rates used to help spur inflation also risk fueling a housing market boom that some warn is developing into a bubble.

In discussing the inflation target review last year, Deputy Governor Agathe Cote also said the bar for change was high.

Cote, who joined the central bank in 1982, lived through the experience of introducing the target. One source, who spoke on condition of anonymity, said Cote conveyed in a private briefing that she has not forgotten the huge challenge of achieving a credible target.

The Bank of Canada did not comment on what Cote may have said in private briefings but said "the bar for change is very high. Our flexible inflation-targeting regime has served Canadians extremely well."

It noted that the appropriate level for an inflation target is a research topic for central banks around the world, adding it would not preempt research by declaring a position.

While most consider adoption of a higher target in 2016 very improbable, Bank of Montreal Chief Economist Doug Porter does believe the bank is seriously considering it.

Bank of Nova Scotia's Derek Holt attaches 30 percent odds to a higher target, while Royal Bank of Canada Chief Economist Craig Wright put the likelihood of change at close to zero.

(With additional reporting by Jonathan Spicer in New York; Editing by Jeffrey Hodgson and Alan Crosby)