Bank of Canada deputy governor Rhys Mendes said the central bank is considering abandoning the practice of referring to measures of

core inflation as its “preferred” measures, as the central bank prepares to review its monetary policy framework next year.

“In practice, our preferred measures are just some of the many indicators we use to achieve our

inflation target ,” Mendes said during a speech in front of the Ivey Business School. “So this raises questions. Should we broaden our list of preferred measures? Or perhaps even end the practice of identifying some measures as ‘preferred’?”

Mendes said the characterization of CPI-trim and CPI-median as its preferred measures has often led markets to place more emphasis on core measures than the central bank does.

He added that during the July and September interest rate decisions, the central bank began to focus more on

underlying inflation , which is often used more as a concept than a measure. Underlying inflation takes into account the bank’s preferred measures of core inflation, but also incorporates widespread inflationary pressures.

Mendes said there was growing discrepancy between where measures of core inflation stood, hovering around three per cent, and where underlying inflation stood, at an estimated 2.5 per cent.

“The difference might not seem like much, but in the realm of monetary policy, it is important,” said Mendes. “Half a percentage point can mean the difference between a decision to

hold interest rates steady or to cut them.” In September, the central bank opted to cut its policy rate by 25 basis points to 2.5 per cent.

Mendes said one of the central bank’s challenges is that changes in the policy rate often take time to filter through the economy. This means the bank has to look through the noise and temporary spikes to inflation.

“But interest rate changes work with lags,” said Mendes. “This means we cannot — and should not — try to react to every wiggle in the monthly inflation numbers.”

Mendes said core inflation has played that important role of stripping out temporary volatility, with the preferred measures of CPI-trim, CPI-common and CPI-median, first introduced in 2016. CPI-trim removes the top 20 per cent and the bottom 20 per cent of price changes each month and CPI-median lines up all the monthly price changes from lowest to highest and picks the middle.

In 2022, the central bank decided to stop using CPI-common, which tracks price changes that are common across categories, due to unusually large historical revisions during the post-pandemic inflation surge.

“And while our remaining two preferred measures have generally been helpful, they were less reliable during some periods,” said Mendes. “This is yet another reminder that, when assessing underlying inflation, we must look at a range of different indicators.”

Mendes said looking forward, the central bank expects underlying inflation to ease, as the two main contributors such inflation in prices for shelter services and inflation in non-energy goods are expected to cool.

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“For example, rental markets are softening, which should help keep inflation in prices for shelter services on a downward trend,” said the deputy governor. “And growth in input costs has largely normalized, which should help cool inflation in non-energy goods prices.”

Looking ahead to the central bank’s mandate review next year, Mendes said the Bank of Canada is also considering pre-excluding mortgage interest costs from its preferred measures and alternative preferred measures.