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April Inflation – The Core of the Matter

23 May 2023

A jump in headline inflation has caused a rethink in the market about a possible rate increase. The bond market is now leaning towards another 25-basis point increase this summer.

April inflation data showed an acceleration in prices. The headline Consumer Price Index (CPI) figure rose 4.4% year-over-year in April, up from 4.3% in March. This was the first increase in the headline number since June 2022. Energy prices were the main factor, with prices at the pump rising 6.3% month-on-month. Adding to this were rising rent and mortgage interest costs.

Shelter costs make up a large part of the CPI. The challenge with a durable good such as housing is it provides services well beyond the purchase date. Statistics Canada uses a simplified user-cost approach to measuring shelter costs when estimating the services that are provided. In the methodology used by Statistics Canada, rising rents (up 6.1% year-over-year) and mortgage interest costs (up 28.5% year-over-year) are included into the CPI gradually, while resale price changes are more immediately registered in the index. The downward trend from last year’s house price correction has mostly disappeared, and we are starting to see gains in some markets. The replacement cost component is stabilizing, while the ‘other’ component, which picks up transaction prices, increased in April after falling over the last 10 months.

The Bank of Canada’s core inflation metrics, however, were down in April. CPI-median inflation was down to 4.2% year-over-year from 4.6% in March, while CPI-trim fell to 4.2% from 4.4%. On a three-month annualized basis, both accelerated to 3.8% and 3.7%, respectively. This suggests that while core inflation measures continue to improve, there is some underlying stickiness. A core rate of 4% is too high for the Bank. The question is – is a policy rate at 4.5% (leaving us with a slightly positive real overnight rate) sufficiently tight? The Bank will be looking at the more interest-sensitive sectors of the economy and the job market to see where rates will need to move.

Insight into the Bank’s assessment of interest-sensitive sectors can be seen in its most recent Financial System Review where it highlighted vulnerabilities in the financial system. It highlighted the extent of rate resets for mortgagors as one of the key vulnerabilities. Simulations based on the Bank’s expected path for interest rates show that, relative to February 2020, about 47% of all mortgages will face upward adjustments in payments by the end of this year. This process will continue until the end of 2026. Most of this adjustment is expected in 2025 and 2026, when variable-rate mortgage holders face mortgage renewals. For these borrowers, payment increases could be as high as 40% based on the current expected path of interest rates. For fixed rate borrowers, payment increases could be 10% to 25% higher.

These are projections, and much can happen by 2025 and 2026. However, as consumers prepare for this coming household budget shock, we expect that there will be a rebalancing of discretionary spending. Perhaps the 1.4% fall in retail sales in March is the first sign of this adjustment.

 Independent Opinion

The views and opinions expressed in this publication are solely and independently those of the author and do not necessarily reflect the views and opinions of any person or organization in any way affiliated with the author including, without limitation, any current or past employers of the author. While reasonable effort was taken to ensure the information and analysis in this publication is accurate, it has been prepared solely for general informational purposes. Any opinions, projections, or forward-looking statements expressed herein are solely those of the author. There are no warranties or representations being provided with respect to the accuracy and completeness of the content in this publication. Nothing in this publication should be construed as providing professional advice including investment advice on the matters discussed. The author does not assume any liability arising from any form of reliance on this publication. Readers are cautioned to always seek independent professional advice from a qualified professional before making any investment decisions.

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