Mortgage costs keep inflation high, economists say

While the latest Statistics Canada inflation data shows signs of improvement, it reveals that shelter inflation continues to be a challenge for the Bank of Canada — and is fuelling concern over the delay in lowering interest rates.

Last month inflation fell to 2.9 per cent, but shelter costs (rent, mortgage interest costs, homeowners’ replacement costs, water, fuel, and electricity) drove overall prices up 6.2 per cent year-over-year.

StatsCan also highlighted that mortgage costs were the fastest rising element of the consumer price index, climbing 27.4 per cent from a year ago. Excluding mortgage costs, however, inflation was closer to two per cent — the Bank of Canada’s target inflation figure.

“There’s just this basic assumption that, as interest rates stay high, inflation stays low. Except that’s not what’s happening right now,” said David Macdonald, senior economist at the Canadian Centre for Policy Alternatives. “Now is the time to recognize that and decrease interest rates to see a decrease in inflation.”

According to an analysis by Macdonald, excluding rent and mortgage interest costs — the most sensitive items to changes in interest rates — the Bank of Canada has been meeting its inflation target since May of 2023

 

 

In a note to clients, TD economist James Orlando called the inflation problem “a housing issue,” adding that, the longer the central bank keeps rates at current levels, the longer Canadians will suffer from “a heavily restrictive policy rate.”
Mortgage costs are passed on to renters

 

 

While high interest rates have been successful at cooling overall prices, the main concern is that they are fuelling shelter inflation through mortgage interest costs, which are, in part, passed onto renters. In turn, high shelter inflation impacts overall inflation, preventing central bankers from relieving interest rates in a form of snowball effect.

But cutting rates too quickly can risk boosting resale home prices which could further derail inflation, said Robert Kavcic, senior economist at BMO.

“You’ll get some relief on mortgage costs but at the expense of higher house prices,” he said. “If they are going to miss this in one direction, they’re probably going to miss it in the direction of leaving rates too high for a little bit too long rather than cutting rates too soon and having to go through the whole inflation fight again.”

Bank of Canada governor Tiff Macklem has repeatedly emphasized that the bank needs to see inflation “sustainably” on path to target to begin cutting rates. The bank is currently projecting inflation to return to two per cent in 2025. Several economists maintain that the first interest rate trim will come this summer.
‘We are trying to balance the risks’

 

 

In January, Macklem acknowledged the threat of shelter costs on inflation in the opening statement of the latest monetary policy announcement.

“Tightness in some parts of the economy is continuing to hold inflation up. The most prominent of these is housing,” he said. “All this push and pull on inflation means that further declines in inflation are likely to be gradual and uneven. That suggests the path back to our two per cent target will be slow, and risks remain.

“We are trying to balance the risks of over- and under-tightening,” he added. “We don’t want to cool the economy more than necessary. But we don’t want Canadians to have to continue to live with elevated inflation either.”

In an essay published by the Centre for Economic Policy Research in February, Macklem recognized that the bank has made inflation forecast errors in the past and that the prolonged period of high inflation may have “undermined the trust that Canadians have in their central bank.”

He reinforced the bank’s commitment to reaching target inflation. “We are well on our way to restoring price stability, and we need to stay the course.”

 

This article was reported by The Star