Never has it been so obvious that government data on housing costs don’t reflect the cost of buying. Home prices are on a tear, and while CPI’s shelter component is high, it’s miles away from soaring home costs. That’s because of the way it’s measured, says BMO chief economist Douglas Porter. Here’s his breakdown on what’s driving the trend, and why it will fail to reflect reality for most.
Canadian Shelter Costs Have Jumped A Record… 4.3%? WTF?
The cost of housing, aka shelter, made the biggest jump in over a decade. The CPI-Shelter component saw annual growth reach 4.3% in June. It was the largest print since 2008, but not even close to the gains people have seen for home prices. “… [it’s] a long way from what home prices are doing,” he said.
The drivers of the trend break down into two large, but opposite, sub-components. The first is homeowner replacement costs, which reflect the cost of replacing a home (i.e. new home prices). The second is mortgage interest costs, a.k.a. the price to borrow debt.
Homeowner Replacement Costs Soar To A 34 Year High
The lion’s share of growth came from homeowner replacement costs. It’s one of the largest sub-components of CPI-Shelter and increased a massive 12.9% in June. “A 34-year high — albeit barely half the rise in existing prices,” said BMO.
For context, the bank shared existing home prices increased 24.4% over the same period.
Mortgage Interest Costs Are Dragging The Index Down, and Will Continue To Do So
The huge increase in homeowner replacement costs is weighed down by mortgage interest. The cost of borrowing a mortgage is a massive part of the index, and showed an annual DECLINE of 8.6% in June. It was an all-time low for the annual change.
If you already have a home and are up for refinancing, this is great news. People buying homes aren’t saving anything, since the cost of credit is related to the price of homes. Darn!
“This metric gradually adjusts to mortgage rate changes over time, and will remain a brake on the CPI for some time yet,” he said. “Meantime, in the middle, rents are starting to tick back up again after relief last year, rising just over 2% [from last year].”
The combination of factors normally doesn’t happen at the same time. Fast-rising home prices are a sign of a strong economy, where interest rates are rising. Both homeowner replacement costs and mortgage interest metrics should advance together. This should accelerate CPI shelter in tandem.
In a weak economy, home prices aren’t supposed to rise very quickly. Interest rates are usually cut to stimulate weak demand. Both of these metrics should work together to drag CPI shelter lower.
At some point, someone made a wrong turn at Albuquerque. They decided to stimulate demand before it fell off, hoping to prevent any decline in home prices. What we’re left with is record housing activity, and low rates to stimulate it. They took steroids for a kindergarten tug of war match. Now the data has no idea what to make of it. It doesn’t reflect reality. But it’s not exactly contrary to it either.
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