Can inflation go down faster than the central bank expects?

Home prices continue to grow these days in Canada. In 2022, shelter inflation, including rent, mortgage interest costs, homeowners’ replacement costs, and some other expenses, went up from 6.6% in August to 7.2% in November, Capital Economics says.

One of the main drivers of that increase was mortgage interest cost. If the central bank raises its key lending rate again to 4.5% in January, according to Capital, mortgage costs inflation will go up from 14.5% to even more than 26% in April.

However, there may be some light at the end of this tunnel. Capital believes that in a few months, shelter inflation will go down significantly as lower housing prices will contribute to stabilization.

Capital says homeowner replacement costs (depreciation driven by new home prices, excluding the cost of land) will soon turn negative, as well as other expenses.

The report says new home prices may go down in 2023 due to lower construction costs and real estate commissions.

The most unpredictable issue is rent. Rent inflation kept growing in November, with the average listed rent going up by 12.4% on a year-over-year basis to a record high of $2,024, Rentals.ca says.

In Capital’s opinion, this growth will ease during the next months, as the labour market weakens and a record number of new apartments are built in Toronto. Nevertheless, Ottawa’s ambitious immigration targets may change this forecast.

According to Capital, the Consumer Price Index rent inflation will be within 6-7% limits this year.

Nevertheless, economists believe shelter inflation will go down slightly in the first quarter of 2023 and reach 3.5% by June. In case the BoC doesn’t raise its overnight rate beyond 4.5%, mortgage cost inflation will fall in the second half of the year.

Further, by the end of the year, Capital expects shelter inflation to stop at 1.5%. Although it’s not enough to bring today’s inflation of 6.8% back to the Bank’s target of 2%, Capital also predicts inflation deceleration in the sectors of energy, food and goods during a moderate recession we are heading to.

“That’s why we still think the central bank is underestimating how fast the overall inflation will go down. In our opinion, the headline inflation will get close to 1.5% in the fourth quarter of this year, while the BoC predicts 2.8%. Lower inflation should force the Bank of Canada to reduce its key lending rate to 2.5% at the start of 2024,” – says Capital economist Stephen Brown. If it happens, it will be a relief for many.