'The Bank of Canada’s inflation problem is mostly a housing issue'
Persistently high shelter costs remain the most prominent threat to the Bank of Canada’s efforts to restore overall inflation to its 2% target, according to a new TD report.
Mortgage interest costs swelled by 27.4% in January compared with the same time last year, new inflation figures by Statistics Canada showed on Tuesday, with rental inflation jumping by 7.9% on a year-over-year basis.
Those surges helped push shelter inflation to an annual rate of 6.2%, even as the overall inflation rate dropped to 2.9% in January.
“Given its huge 30% weighting within the CPI [consumer price index] basket, this component [shelter] alone has accounted for more than half of overall Canadian inflation,” TD director and senior economist James Orlando said in a note following the release of the latest CPI figures.
Shelter inflation, he added, has become “the biggest hurdle” preventing the Bank of Canada from cutting rates – and with the central bank largely powerless to bring shelter prices down immediately, Orlando said it could “start looking past” the influence of shelter inflation.
“As long as the BoC continues to focus on inflation metrics which are being held up by shelter inflation, Canadians will suffer under the weight of high interest rates,” he wrote.
The Consumer Price Index (CPI) rose 2.9% on a year-over-year basis in January 2024, following a 3.4% gain in December 2023.
— Statistics Canada (@StatCan_eng) February 20, 2024
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Could the Bank of Canada focus on other inflation measures?
Orlando said the influence of shelter costs had kept underlying inflation measures higher in Canada than other major economies, and that using the US Federal Reserve’s preferred inflation metric would actually adjust Canada’s inflation rate to just above the 2% mark.
“What’s interesting is that if we calculate Canadian inflation using the same weights as the Fed’s preferred metric, Canadian inflation would be at just 2.1% [year over year],” he said.
“Even the BoC’s former preferred measure of core inflation (CPIX) that takes out mortgage costs and other volatile items is at 2.4% [year over year].”
TD laid out three scenarios based on different timelines for central bank rate cuts, finding that early rate cuts would see mortgage interest and rent inflation fall faster than if the Bank decided to start lowering rates later in the year.
It also highlighted the looming risk posed by potential mortgage payment increases if the central bank does not begin cutting rates imminently.
“Unless the BoC cuts rates to below 2% this year and even lower in 2025, the majority of people that renew their mortgages over the coming two years are in for a big payment shock,” Orlando said.
Is shelter inflation here to stay?
Meanwhile, continuing low supply of rental housing, coupled with high population growth, means there’s little indication that rent inflation will subside soon.
“It will take many years for this to unwind,” TD’s report said, “which means that rent inflation will remain above overall inflation for the foreseeable future.”
With shelter inflation likely to remain a “major thorn in the side” of the central bank, TD cast doubt on the prospect of overall inflation returning quickly to the 2% target.
“[Shelter inflation] isn’t going away no matter how quickly it decides to cut rates,” Orlando said. “While we have been arguing for the Bank to begin looking through the shortcomings created by shelter inflation and instead focus on the health of the broad economy, it is clear from recent central bank communication that it isn’t ready to do so.
“And the longer the BoC continues to look at inflation through its current lens, the longer Canadians will have to bear the weight of a heavily restrictive policy rate.”
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