A surge in mortgage costs is contributing to 28.6% of overall inflation
The Bank of Canada set out its stall for the year ahead in its first interest rate decision of 2024 last week, reaffirming what was already clear: that bringing down inflation remains its number-one priority for the next 12 months.
While it held its benchmark policy rate steady in that announcement, the central bank also expressed its concern over the inflation outlook and reiterated the importance of core inflation continuing to ease.
Mortgage interest payments, which have swelled since the Bank began hiking rates in 2022, continue to represent one of the most significant contributors to annual inflation, spiking by 28.6% on a yearly basis in December.
With that in mind, could cuts to the Bank’s policy rate – currently at its highest level since 2001 – help put a dent in inflation by bringing down those soaring borrowing costs?
Mortgage, shelter costs excluded from key BoC inflation measure
The cost of servicing a mortgage might be driving up overall inflation, but the Bank is unlikely to use it as a reason to lower rates imminently, mainly because it’s probably excluded from some of the most important inflation measures it studies.
Among those is CPI-trim, an inflation measure that excludes 20% of weighted monthly price variations at both ends of the distribution of price changes – essentially removing 40% of the total CPI.
Dominique Lapointe (pictured top), director of macro strategy at Manulife Investment Management, told Canadian Mortgage Professional that while the Bank does not disclose what’s included in that measure, “you would guess that mortgage interest costs, at [around] 30% of inflation, is excluded from that index.”
That means there’s little chance of the Bank striking a more dovish tone on the inflation outlook, he added, with mortgage and shelter costs probably already taken out of its core measures.
Sal Guatieri from BMO notes the recent language in the Bank's rate announcement, indicating the end of the rate-hiking cycle and a potential reduction unless unexpected economic shifts occur.https://t.co/ExhJVvM1jU#mortgageindustry #industrytrends #ratehike #interestrates
— Canadian Mortgage Professional Magazine (@CMPmagazine) January 29, 2024
Meanwhile, the fact that rates have stabilized, and are likely to tick downwards by the end of the year, will also mean immediately addressing that mortgage payment inflation surge isn’t a top priority for the Bank compared with other measures of inflation.
“Once interest rates settle, and we’ve seen that over the past month or two – this component will decline, because it’s based on the past change in mortgage rates,” Lapointe said. “So when we’ve seen mortgage rates setting in, the change goes negative, and that component will roll over.
“They can actually say, ‘We know when it’s going to come down, so we’re not worried about this inflation – but we’re not also discounting it.’ They’re not going to lean hawkish nor dovish because of it.”
How will the US Fed influence the Bank of Canada’s approach on rates?
The US Federal Reserve’s first rates meeting of the year takes place this week hot on the heels of the latest Bank of Canada decision, with market observers north of the border taking a keen interest in the Fed’s approach and what it could mean for Canada.
Like Canada’s central bank, the Fed has hit pause on rate hikes in recent times after a series of aggressive increases in 2022 and the first half of 2023, and is expected to begin cutting at some point this year.
The US economy has thus far defied projections of a sharp and painful downturn, posting stronger growth than expected in the fourth quarter amid hopes that inflation can be returned to the 2% target without triggering a recession.
Still, that’s unlikely to increase the risk of further rate hikes this year, Lapointe said, with odds still firmly on cuts both in Canada and the US.
“I think there’s an upside risk coming from the US,” he said. “At the same time, the Fed is betting on the soft landing.
“So it doesn’t mean that rates will be higher for longer because the US is doing well – I think the Fed might look to cut interest rates this spring or early summer even if the economy’s doing well because they’ve made progress on inflation. The Bank of Canada will also be in a position to do so.”
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