Inflation debunked: economist reveals why rate hikes aren't the issue

Other crucial factors seen as main causes of inflation

Inflation debunked: economist reveals why rate hikes aren't the issue

Rate increases are not inflationary because of the way housing expenses affect inflation and the rising demand for rental homes. This is a result of the mechanisms through which housing expenses affect inflation and other important issues. This is Senior Economist Robert Kavcic’s response to questions on whether rate hikes are inflationary since rising rent and mortgage prices continue to propel the CPI.

According to Kavcic, the housing sector of the Canadian CPI is intricate and contains several moving pieces, all of which react differently and with varying delays. Broad shelter expenses, which make up slightly under 30% of the CPI basket, were the main cause of April's 4.4% y/y inflation rate.

Under that heading, there are four main aspects of housing that are undergoing significant changes because of changes in the housing market and interest rates: replacement cost (i.e., home prices), other owned accommodation expenditures (i.e., real estate fees), mortgage costs, and rent. Home prices and real estate costs adjust to changes in the underlying market considerably more quickly, and in April they were deflationary overall, reducing the annual CPI by around 0.2 percentage points.

Headline inflation in April has been significantly influenced by mortgage interest expenses as well as fluctuations in market interest rates. By analyzing previous changes in property prices and variations in market interest rates, StatCan combines an interest cost burden.

While interest rates have managed to temper demand more generally, housing expenses were increasing at an 8.1% y/y rate, contributing 2.4 ppts to the headline CPI. About a whole percentage point has been taken off the cost of housing, and interest rates have helped to moderate demand overall. Core goods inflation is roughly 2 percentage points below its peak in early 2022.

The cost of rent is the last component of shelter costs, and it is a challenging one since changes in market prices are incorporated into the official inflation index relatively gradually. Rent appears to be continuing to drive inflation higher as it added 0.4 ppts to the headline CPI in April.

If so, are the increased mortgage rates being passed on by the landlords or are there just too many individuals vying for the same supply of housing? Kavcic thinks it’s the latter.

With a 1 million-strong surge in Canadian population over the previous year, driven mostly by more than 600k nonpermanent residents, the significant change in the rental market that is fueling inflation has come on the demand side.