Canadian Real Estate Price Growth and Low Inflation “Almost Comical”: BMO

Canadian real estate prices are rising at a rapid rate, but officially the cost of living isn’t moving. What gives? Douglas Porter, BMO chief economist, discussed inflation and home prices in 2 separate notes this week. The issue has to do with how official inflation numbers are measured. Housing tends to influence inflation in an “indirect and delayed fashion.”

Home prices don’t normally rise this fast in the best economies, so during a recession is odd. The HPI, which measures resale prices, climbed over 17% in the past year. Porter says, “yet it’s almost comical that [CPI] shelter costs overall in February reportedly rose a mere 1.4%.”

In fact, shelter costs are now officially growing at a slower pace than last year. Total CPI only experienced a 1.1% annual increase in February. Why? Here’s four points he mentions to unpack the disconnect between housing and inflation.

Home Prices Directly Only Have A 19% Weight In Shelter Costs

The economist doesn’t dive into the details of the points, but they’re straightforward. If home prices only reflect 19% of shelter costs, they don’t totally capture home prices. That becomes a big issue when home prices rise more than the median household income in a year.

Rent Costs Have Receded To Nearly Flat In The Past Year

Logically, when home prices rise, the cost of renting rises as well, right? Well, not in Canada. Rents have been falling while home prices have been making a sharp increase.

Porter said, “rents plunged in the past year, [with growth] quickly going from a three decade high in late 2019 to a 60-year low now.” He adds, “rent has a larger weight than home prices at just over 6% [of the overall index].” That’s almost a point higher than homeowner replacement costs, which are based on new home prices.

Electricity Costs Have Dropped 3%

Pandemic subsidies and low commercial demand has helped electricity prices drop. This is largely temporary, and should normalize as commercial energy use rises again. In the meantime, the drop is keeping inflation lower.

Mortgage Interest Rates Have Dropped 5%

Falling mortgage interest rates help to keep inflation low. If you are refinancing, mortgage interest rates are cheaper, and so are your costs. If you’re buying a home, and cheap debt is extended to already frothy markets, costs went higher. Mortgage interest more accurately measures costs for older people that already have housing.

Porter sees rising yields bringing the mortgage interest rate component higher. “The mortgage cost index is smoothed over time, and turns only slowly,” he notes. Even as mortgage interest rates rise, it won’t have a significant near-term impact on prices. 

Overall, he sees the CPI hitting levels many thought were impossible. It just won’t reflect the kind of cost increases people are seeing in housing. “booming home prices will begin to add modestly to inflation in the year ahead, but the impact will be barely perceptible.”

He further adds, “this seeming disconnect between soaring home (and other asset) prices on the one side, and mild underlying inflation readings on the other, will only reinforce the perception that CPI doesn’t reflect reality.”

“Even the coming 3%+ headline CPI figures won’t impress, given that gasoline prices are almost 50% above last spring’s levels,” says Porter. Finishing with, “certainly bond investors are heavily leaning to the view that regardless of current readings, the inflation risks are tilting higher.”

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  • Fazid 3 years ago

    I understand inflation can’t be precise. If it can’t, why is it used as a guide for the whole damn economy!

  • Bob 3 years ago

    Central bankers know that the government cannot afford to pay higher interest in its debt as it is rolled over. The interest rate is tied to changes in the CPI, or inflation. Ergo, inflation ‘must always ‘officially’ be low, no matter what real things cost to real people.

  • jason 3 years ago

    Consumer goods and energy prices not following house price growth is completely normal in a housing bubble. When there is a house correction home prices will go back down to what the real value for living space is and not a speculation.

  • SillyWabbit 3 years ago

    I don’t expect housing prices to drop anytime soon or interest rates to rise dramatically. Policy makers and central banks just can not afford to let this happen and are forced to continually intervene to keep interest rates low and modify lending policy to support the housing market which is up globally. There are options on the table for policy makers and central banks such as shifting the weight of bond buybacks towards the 10 year, extending amortizations to 30, 35, or 40 years and removing the stress test. The bottom line is the public is onto the fact that we are stuck in the mess and can’t afford to allow the market to correct. Unfortunately, a lot of younger people, and lower income households are getting screwed due to this. Perhaps we should have let this market crash a decade ago and begun putting policies in place to stimulate real economic development and not just housing. Good luck to all.

  • Scott MacKinnon 3 years ago

    This is the most expensive re election campaign in Canadian history…

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