Canadian shelter costs are soaring, but haven’t contributed much to inflation data. That is, until now. Statistics Canada (Stat Can) updated its consumer price index (CPI) for May. The index is accelerating at the fastest rate in over half a decade, and for the most part — it’s not base-effect. Gasoline and shelter costs were the biggest drivers over the past year. The latter is not even being fully captured, with economists saying it tends to be delayed.
Inflation Is Rising At The Fastest Rate Since 2011
CPI is rising at one of the fastest rates in years, and the agency is changing its tune about it being a base effect. Seasonally adjusted monthly growth came in at 0.4% in May, while annual growth reached 3.6%. The month prior saw annual growth at 3.4%, so we are witnessing an acceleration in growth. The agency said it was the largest annual increase since 2011.
Canadian Consumer Price Index Growth
The rate of annual growth for the Canadian consumer price index (CPI), and CPI if gasoline was excluded.
Source: Stat Can; Better Dwelling.
Adjusting for gasoline, the inflation measure somehow falls by almost a third. CPI excluding gasoline only saw annual growth come in at 2.5% for May. That brings up a lot of questions about the weight of gasoline. Official data is estimating the rise in price for the good increased the cost of living by a third. That’s highly unlikely, but weight issues are a different story for another day.
Inflation Isn’t Just Skewed By A Base Effect
It’s just a base effect, right? A few weeks ago we highlighted the lack of base effect in the index. Few components were actually subject to any skew, yet that was the official story. Stat Can appears to have finally agreed, saying few components were impacted. Glad that’s cleared up — better late than never.
Shelter Is One of The Largest Contributors To Inflation
Shelter is the largest single component of CPI, and soaring costs were a big influence last month. CPI-shelter made a monthly increase of 0.7% in May, bringing annual growth 4.2% higher. It was the largest annual increase since September 2008. Though many of you are probably thinking, “WTF? How is it only 4.2%?” Let’s take a quick dive into CPI’s shelter component.
Two major sub-components of shelter are heading in opposite directions. This has minimized the impact of shelter in the contribution to inflation data. The first is the homeowner’s replacement costs.
Homeowner replacement costs are the cost of replacing all, or parts, of a home. You may have only heard it called “replacement costs” in insurance. Annual growth in this sub-component was up 11.3% in May, the largest jump since 1987. It has increased throughout the pandemic, but often delayed compared to real costs.
Canadian Consumer Price Index Shelter
The annual rate of growth for CPI shelter’s sub-components of mortgage interest costs and homeowners’ replacement costs.
Source: Stat Can; Better Dwelling.
The second major sub-component is dragging this measure lower — mortgage interest costs. Mortgage interest costs have made an annual decline of 8.2% in May. The government tends to conflate cheaper to borrow with more affordable. They never quite factor that lower rates allow home prices to rise more easily. The rate cuts mortgage borrowers received more than absorbed rising costs.
In an ideal world, the cost of borrowing drops and home prices don’t rise. It just becomes more affordable to buy, which is usually the case during a recession. However, during a bubble when any downside is covered by the government, it only pushes prices higher — as we just saw.
The moral hazard meant the cheaper costs are fueling higher home prices. CPI isn’t equipped to measure misallocation due to poor governance. The result is the only people saving money are existing homeowners that are refinancing or renewing. Low mortgage rates are keeping interest rates low… it’s almost a self-reinforcing feedback loop at this point.
Economists warned shelter costs would eventually appear in the CPI. However, they said it would be delayed, and not reflect the entirety of what’s happening. BMO actually described the situation as “almost comical.” It’s finally starting to show up, and it definitely isn’t a reflection of what’s happening. The exception being existing homeowners that aren’t upgrading, and need to refinance now. That or someone that can borrow today, to buy a house a year ago.
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