Central bank shouldn't let shelter inflation slow rate cuts, says BMO economist
The Bank of Canada (BoC) should avoid placing too much focus on rising shelter inflation when making future interest rate decisions, according to Bank of Montreal economist Robert Kavcic, arguing that these would lead it to “cut rates too little/too late.”
The central bank shouldn't “get hung up on shelter inflation," Kavcic said in an emailed statement to Yahoo Finance Canada. He explained that giving too much weight to rent and mortgage costs, which are slow to show up in inflation data, could result in the central bank "cutting rates too little, too late."
A quarter of inflation
The shelter component of the Consumer Price Index (CPI), which includes rent and mortgage costs, accounts for roughly a quarter of Canadians' spending.
BoC governor Tiff Macklem Macklem acknowledged the difficulty of lowering inflation to the Bank’s target of 2% when a quarter of the inflation basket is driven by shelter costs.
"Shelter price inflation is still too high and remains the biggest contributor to overall inflation, despite some early signs of easing," Macklem said during the BoC’s recent announcement of its third consecutive rate cut.
However, Kavcic pointed out that changes in shelter costs are slow to be reflected in CPI data, which could skew the BoC's view of inflation. He also noted that, excluding shelter, CPI has grown at less than 2% year over year for the past seven months.
Many Canadians are already experiencing significant mortgage payment increases as they renew loans at higher rates than during the pandemic. These rising mortgage costs are contributing to higher CPI figures, but Kavcic emphasized that the broader housing market is starting to stabilize.
Mortgage costs for new buyers are decreasing due to falling interest rates, and “market rent has stabilized even before population growth cooled and with more completions in the pipeline,” Kavcic said. Additionally, the housing resale market “hasn’t responded to rate cuts in any concerning way. It hasn’t really responded at all, yet.”
Read next: Bank of Canada: Rent prices may drop, but don't expect home prices to fall
Macklem made a similar point during the rate cut announcement.
“With mortgage rates coming down, hopefully with more supply coming into the rental market, with some reduction in population growth, you should see rent prices come down,” he said.
“It’s going to take more time”
While lower mortgage rates could eventually improve affordability, experts suggest it will take time for rate cuts to make a meaningful impact on the housing market.
In Toronto, housing market conditions softened in August, with listings-to-sales ratios hitting their loosest levels since 2008, excluding the COVID-19 period, according to National Bank economist Daren King.
Similarly, home sales in Vancouver dropped 17.1% from the previous year, based on data from Greater Vancouver Realtors.
“It’s going to take more time,” RATES.CA mortgage expert Victor Tran told Yahoo Finance Canada. “Even a drop of a full percentage point from current mortgage rates would not result in a significant increase in buying power given persistently high home prices.”
John Lusink, president of Right at Home Realty, echoed this sentiment, stating that the housing market is unlikely to see significant changes until at least two more rate cuts are implemented.
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