For the first time in over three years, headline inflation has returned to 2 per cent, down significantly from 2.5 per cent in July. Core inflation measures are all trending at or below 2.5 per cent over 3- and 6-month periods. Excluding mortgage interest costs, the year-over-year inflation rate was only 1.2 per cent, while the Consumer Price Index (CPI) excluding shelter costs was up just 0.5 per cent compared to last year.
The housing component of the CPI continues to be stubbornly high. Rent increased by 1 per cent in the month, marking the largest increase this year and lifting rental rates 8.9 per cent from a year ago. Although mortgage interest costs have slowed to an 18.8 per cent year-over-year increase, the housing component is expected to remain elevated for some time due to the way it’s calculated.
The CPI index for owned accommodation is measured through six components: 1) Mortgage Interest Cost; 2) Homeowner’s Replacement Cost; 3) Property Taxes and Other Special Charges; 4) Homeowner’s Home and Mortgage Insurance; 5) Homeowner’s Maintenance and Repairs; and 6) Other Owned Accommodation Expenses.
Statistics Canada uses a complex methodology to factor in mortgage rates and housing costs, weighted over the past 25 years – the standard mortgage amortization period. If interest rates are high to combat inflation, mortgage servicing costs will typically rise; conversely if rates are low, mortgage servicing costs will decrease. As a result, a low Bank of Canada policy rate reduces mortgage servicing cost inflation, and vice versa.
The Bank of Canada clearly recognizes this connection but has not looked through this policy-induced component of the CPI. With third quarter growth expected to fall short of its forecast, the Bank highlighted a shift in focus toward the gradually weakening economy in its most recent policy announcement.
Recent changes to mortgage insurance rules, including increasing the insurable limit from $1 million to $1.5 million and expanding 30-year amortization eligibility for insured mortgages, seem aimed at stimulating condo market activity and preventing a slowdown in building activity. Without support from the Bank of Canada, this adjustment will be slow.
With inflation now within target, will the Bank of Canada lower rates more aggressively to reduce mortgage costs for borrowers and construction costs for builders? Moving more quickly on rate cuts would also benefit borrowers facing higher mortgage rates at renewal in the coming year. This should help offset the expected decline in discretionary spending and, more importantly, improve affordability. Unfortunately, the Bank doesn’t think this way and is unlikely to act more aggressively unless economic conditions worsen significantly. Barring a horrendous employment number in September, the Bank is likely to lower its policy rate by 25 basis points in October. If the economy weakens further, there is a good possibility the Bank will act more aggressively in December.
Independent Opinion
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