Financial markets are betting that both the US Federal Reserve and the Bank of Canada will raise rates very slowly, as they leave room for inflation to heat up to their targets. The target is to have inflation average 2% over the medium-term, measured by the CPI in Canada, and the core PCE price index in the US. But to hit that target, central bankers might have to behave like an archer looking at a distant target: aim high.
Todays’ Canadian CPI data hinted that inflation may finally be climbing again. But yields on real return bonds in Canada, which pay a fixed rate of interest plus inflation, build in the assumption that inflation will average well below 2% for the next five or ten years, based on the level of inflation needed to make them equivalent to regular government bonds.