Sharply cooling real estate market contributes to easing Canada’s inflation

Due to the current housing costs and the way they affect Canada’s inflation, consumer price growth may slow down sharply in the nearest future.

Being the main expense for most households, shelter accounts for about 30% of Canada’s consumer price index (CPI), just like in the U.S. However, unlike our neighbor, Canada’s inflation captures these prices in a way that is much more sensitive to any fluctuations in interest rates and real estate costs.

In other words, Canadian inflation is affected not only by an increase in mortgage costs when the central bank raises its overnight rate, but by the resulting slowdown in the housing market as well.

Although inflation still reached 6.3% last month, price pressures are expected to slow down due to base effects and the ongoing cooling in the national real estate market, which applies to shorter-duration mortgages than the U.S. and a higher amount of variable-rate home loans.

Based on such differences, economists believe that the Bank of Canada, which announced last week it plans to pause its rate-increase cycle, will not have a reason to raise its overnight rate as high as the Federal Reserve.

“Canada stands out from many other countries in a way that the central bank’s rate hikes lead to a temporary boost to inflation,” – Stephen Brown, an economist at Capital Economics, noted.

As you know, shelter has been the main driver of Canadian inflation recently, rising by 7% in December. The mortgage interest and rent sub-indexes reported annual gains of 18% and 5.8%, respectively.

Nevertheless, as rates are on hold now, Brown says mortgage interest costs will reach their peak and then fall significantly in the second half of 2023. Other inflation components, e.g. commissions on home sales, are already slowing down.

In his opinion, hikes in the shelter component of CPI will go down to 3.5% by June and to 1.5% by December. As energy, food and goods prices may also go down drastically, Brown believes the BoC could be “underestimating how fast the overall inflation will drop.”