Bank of Canada Just Made Its Most Disturbing Speech In A Generation

Canada’s central bank just delivered a speech that made every quant’s skin crawl. Last week, the Bank of Canada (BoC) revealed it’s preparing a major overhaul of how inflation is measured. In prepared remarks, Deputy Governor Rhys Mendes warned that mortgage costs have distorted the Bank’s preferred CPI readings. Now it’s considering whether to scrap mortgage interest—or its preferred measures altogether—in favor of “underlying inflation,” a concept it describes as less of a statistic and more of a feeling… before citing it as the statistic used to justify its latest policy move. 

Canadian Monetary Policy & Mortgage Finance 101

Before discussing the BoC’s comments, a quick refresher on monetary policy and mortgage interest 101. The Bank of Canada’s primary job is inflation control—keeping price growth near its 2% target using its key tool: the overnight rate. 

When inflation is low, the BoC cuts rates to encourage debt-fueled consumption and stoke demand. The intent is to create excess demand and drive prices higher (i.e. inflation). When inflation runs hot, rates are hiked to cool borrowing and reduce consumption. Congrats—you now understand inflation and monetary policy better than most politicians.

Mortgage rates directly transmit monetary policy through inflation expectations. Variable rates move with the overnight rate—driven by short-term inflation expectations. Fixed rates, meanwhile, track bond yields, which reflect medium-term inflation expectations. 

In stable, well-managed economies, those rates converge—short and medium-term expectations should move in sync. More importantly, Canada has its own spin on these measures—and it’s not because they figured out how to spell inflation with a U. 

Canada’s Unique Approach To Inflation and Monetary Policy 

As we’ve mentioned many times before, Canada is unique among advanced economies in its approach to inflation measures. Unlike Europe or the US, Canada includes financing costs—specifically, mortgage interest, in its CPI.  

Because shelter is the largest component of the CPI basket, this design gives mortgage costs disproportionate influence over inflation. That’s a problem, as you may have noticed, since mortgage interest is determined by inflation itself. 

This isn’t a misunderstanding—it’s circular logic. CPI drives mortgage rates, and mortgage rates drive CPI. Canada created the monetary policy version of a human centipede. 

Great news for the BoC; not so great for anyone who likes stable prices or rational housing markets. Most central banks have to wait for monetary policy to be transmitted through the economy. The BoC gets instant results. Cut rates, and mortgage costs fall—dragging CPI lower. The downward pressure on CPI then justifies more cuts, inflating home prices with leverage and forcing other CPI components to work harder to offset the drop in mortgage costs. It’s a mystery why home prices are out of touch and the cost of living is still out of control. 

The reverse is equally as absurd. Raise rates, and mortgage costs surge, instantly pushing CPI higher—as if higher borrowing costs were the same as economic growth. The Bank then faces pressures to cut again. All roads somehow lead back to easing. 

So when Canadian policymakers brag about all the times they had the lowest inflation in the G7, it’s worth remembering: Canada isn’t measuring the same thing. 

It’s also worth noting this is Canada’s first major real estate boom-bust cycle since adopting CPI-based inflation targeting in 1991. The BoC previously used money supply targeting, but declared it ineffective once it… well, broke. Let’s put a pin in this, but it’s a point to keep at the top of your mind for the rest of this piece.  

Most Canadians still see this as sound policy, but it creates excessive pain for households since large portions of inflation remain uncaptured. Back in 2021, we noted CPI was rising 30% faster when mortgage interest was excluded. The BoC had adopted the narrative that inflation was transitory, and due to lower rates and fiscal dominance, it quietly pretended it wasn’t intentionally keeping rates low due to model optimization. Eventually it had to hike sharply, resulting in excessive credit throttling and crushing investment. The long-term damage won’t be easy to undo, and simple cuts won’t be enough to reverse it. 

Bank of Canada’s Preferred Core Inflation Measures Filtered Out Mortgages… Until It Didn’t

The BoC is finally acknowledging the problem exists. 

“When interest rates go up, inflation in mortgage interest costs also goes up automatically. And because many Canadians have fixed terms on their mortgages, renewal at new rates happens only gradually. So the effect on inflation can be persistent,” explained Deputy Governor Mendes.  

He warned that mortgage interest costs “obscure the broader response of inflation,” leading to poorly guided policy decisions. Mendes added that some of the Bank’s preferred core measures—CPI-trim and CPI-median—are designed to filter out volatility from categories like mortgage interest. But in reality, they’re failing to do so consistently. 

That failure has prompted the BoC to rethink the inclusion of mortgage interest in its core measures. 

“One question we are asking ourselves is whether we should revise our preferred measures and our alternative measures of core inflation so they all pre-exclude mortgage interest costs. It’s something we’re considering carefully, particularly as we think about how monetary policy and imbalances in the housing market interact—which is one of the other major topics we’re exploring as part of our 2026 renewal,” he said. 

It sounds like a step in the right direction—but misses the mark for one big reason. The BoC sets its own target, determines how it measures progress, and still fails to produce results. The central bank creates the rules, but it still can’t win. 

And if this sounds like self-awareness, don’t get too excited. Mendes went on to ask: “Should we broaden our list of preferred measures? Or perhaps even end the practice of identifying some measures as ‘preferred’?”

Bank of Canada Considers Eliminating Inflation From Its Core 

In one of the BoC’s most bizarre speeches, the Deputy Governor suggested the institution is reassessing how it measures underlying inflation, stating it’s not a statistic. It’s more of a… feeling? 

“Underlying inflation is a concept, not a statistical measure. It tries to capture the persistent—or lasting—part of inflation that is related to economic fundamentals. These fundamentals can include things like imbalances between overall supply and demand in the economy and sustained cost pressures,” said Mendes.

Only to contradict himself moments later, using underlying inflation as a statistic: “Underlying inflation was roughly half a percentage point lower than our preferred measures.”  

In short, underlying inflation isn’t data—it’s a vibe. A vibe that somehow statistically justifies the council’s recent rate decision, which the BoC has since implied may not be effective. 

Short of delivering it through a boombox while wearing a Kangol hat, the BoC speech couldn’t have felt more late 1980s. The inflation measure is always right when it supports the desired result—until it doesn’t. Then it’s a bad way to measure it.