Canadians have been begging for housing costs to have a greater influence on inflation. They’re going to finally get what they’ve been asking for… but it’s going to work against them. The consumer price index (CPI) basket weights got an update from Statistics Canada (Stat Can). One of the biggest changes to the index is going to be an increase to the Shelter component. The increase is likely to push inflation lower due to the design and timing.
The consumer price index (CPI) is a measure of inflation based on a basket weight of goods, updated regularly. If you don’t know what a weighted basket is, it’s just an index made up of various components. The goods are dependent on what Stat Can finds households are spending the most on. Then the changes in those goods are tracked as one movement.
Still not clear what a basket is? Let’s say hot pants were 20% of the basket, because it’s what society spends a fifth of its income on. If the cost of hot pants rises 200%, only 20% of that gain would be captured. You may be spending $100 more, but as far as they’re concerned, your cost of living only increased by $20. It’s by no means a perfect way to measure the cost of living. But planning a monetary supply around the weight of what you perceive society to spend their money on is kind of a fool’s task anyway. That said, it’s a task that has a very real impact on your cost of living. Especially if Stat Can screws it up.
Why Do People Want Shelter To Be A Bigger Part of Inflation?
Inflation influences interest rates, which influence the amount of credit people can borrow. If inflation is persistently high, the central bank increases rates to “cool” borrowing. This increases debt servicing costs, and lowers the size of debt people can draw. Since excessive credit causes home prices to rise, it also helps to tame higher home prices.
The issue is, shelter was a relatively small part of the index. While shelter costs were soaring, officially inflation was low. People were complaining about soaring housing costs, while central banks collected awards for their ability to tame inflation. Had shelter been better captured, it would have shown a rising cost of living much more quickly. This would have resulted in them addressing the housing bubble sooner. Now they’re increasing the Shelter component… during a period where it’s likely to have the opposite effect people had hoped for.
Shelter Will Represent 30% of Canada’s CPI Inflation Basket
The latest update to basket weights is based on 2020 consumer survey data…. because, you know, 2020 was the perfect year to gauge how people spend their money. The previous update was done in 2017, and there have been a few changes since then. One of the most notable is how much people spend on housing, which gets a big adjustment in the CPI basket weight.
Starting in June 2021, the Shelter component of CPI will represent 30.03% of the CPI basket weight. Prior to that, the weight used from 2017 onward was 27.36%. The 2.67 points added are going to have a big impact on inflation. Due to the makeup and timing of the rollout though, it will likely push CPI numbers lower. Much lower.
Rental Prices Will Have Little Change From Before
The size of the shelter component might see a big change, but rent will barely make a difference. Rental accommodations is one of the big three subcomponents of the Shelter weight. Starting this year it will be 6.63%, up from the 6.59% established in the 2017 survey.
That’s right, a whopping 0.04 point increase is going to rental accommodation. If your cost of renting jumped $200, under the old weights $13.18 would be captured. Under the new weight, $13.26 would be captured — a mind blowing $0.08 more. The precision is blinding, and I’m guessing you can already see what’s happening here.
Ownership Costs Capture More of The Inflation Basket, But Will Drive Inflation Lower
The lion’s share of the weight will go to the subcomponent of ownership costs. Owned accommodations will go from 16.80% in 2017, to 19.73% of the basket in 2021. That’s an increase of 2.93 points for the segment. Most of the increase will go towards homeowner replacement costs, mortgages, and “others.” All of these are likely to see deflationary pressures hit.
Homeowner replacement costs are the cost of rebuilding your home with similar components. It’s based on the new home index, and also tracked by Stat Can. This area manages to capture 16% of the increase in points moved to ownership costs. Considering materials like lumber are now plummeting back to reality, it’s odd timing. They’ll give greater weight to the decline in prices, which will appear deflationary.
Mortgage interest costs were reduced by 0.14 points as well, which is actually hilarious. It would make sense if mortgage rates were falling slightly, but that’s not the case. Mortgage rates just got a drop, and then an extra drop due to QE. When they’re expected to climb due to normalization, they’ll be reducing its impact on the total index. Swell, eh?
The rest of the 79% of the point increase will go to “other owned accommodation expenses.” This is an area rarely talked about, and few understand. It’s where real estate commissions and legal fees for home buying are hidden.
Since Realtor fees are usually a fixed percentage of the cost, this varies due to market outcome. If prices stagnate as the industry expects, it becomes a flat anchor for inflation. If home prices pull the C-word, it becomes deflationary pressure.
Energy Costs Will Become A Smaller Component of Inflation
You may have noticed “owned accommodations” increased more than the Shelter component. That’s because the third major subcomponent of CPI shelter lost points — Water, Fuel, and Electricity. Since it’s based on 2020 weights, the assumption is people will spend a smaller share of income on energy.
The electricity component in particular appears to be problematic for costs. It falls 16.28% from its current level. That decline is just in time for Ontario’s forecast 20.6% increase to electricity coming next year. On the upside, “imaginary you” in the inflation model will get a huge discount on the increase.
If the Bank of Canada keeps inflation any more low and stable, more people are going to need a second job.
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