Why Housing Costs Are Rising Inflation, Despite the Housing Recession

A house for sale in Ottawa on June 15.Spencer Colby/The Balloon and the Mail

Canada’s real estate market is crashing as higher interest rates drive away potential buyers. Still, the effects of the slowdown don’t show up in the country’s red-hot inflation numbers.

As the housing sector cools, the cost of owning or renting a home is rising rapidly in the consumer price index (CPI), Statistics Canada’s benchmark measure of inflation. Housing costs rose 7.4 percent in April, the biggest annual gain since 1983.

The increase can be attributed to a number of factors, from rising home energy costs to how Statscan measures price changes homeowners face. To make matters worse, the housing sector is likely to continue to put upward pressure on inflation, in part because mortgage rates are rising to multi-year highs and rents are soaring in urban centers.

Statscan releases its next inflation report on Wednesday. Economists’ median estimate is that annual inflation hit 7.3% in May, down from 6.8% in April, which would be the highest in nearly four decades.

The safe haven, the largest component of the CPI, with a weight of 30 percent, will play an outsized role in the path of inflation, which the Bank of Canada is trying to control with its tightest monetary policy in decades.

Commercial rental prices are rising and many small businesses are finding it hard to keep up

“It seems like every month there is a different source of new inflationary pressures that are emerging, and the latest is that people who are now rolling over their mortgages that maybe they took out three or five years ago are paying more in mortgage interest payments than they they should. previously,” said Royce Mendes, head of macro strategy at Desjardins Securities.

“Obviously this is now another source of inflation for Canadians to deal with.”

The rise in housing costs is something of a reversal, as far as the CPI is concerned. Early in the pandemic, when home prices were soaring across the country, StatsCan’s estimate of home inflation was conservative. That drew criticism, often from opposition federal parties, that the CPI failed to capture the real costs to Canadians.

Home ownership is a controversial aspect of inflation because, unlike consumer goods, say a bag of groceries, real estate is an asset. Statistics Canada aims to track the cost of using a home, rather than owning it, and excludes down payments from its calculations.

“The CPI does not include the purchase of a property because, in this case, we do not consider a house as a consumer good,” Heidi Ertl, director of Statscan’s consumer prices division, told The Globe last year. “We consider it an asset.”

The mortgage interest cost index (MICI) is a component of the CPI that is directly affected by housing market conditions. However, it tracks interest costs rather than total mortgage payments (principal and interest).

Early in the pandemic, mortgage rates fell to record lows, fueling the record tranche of home transactions that followed. But even as rock-bottom rates drove up home prices (for some, to unaffordable levels), the MICI began to fall sharply, acting as a drag on inflation.

That is starting to change. Mortgages are now trading at their highest rates in years, with some major lenders offering five-year fixed rates above 5 percent. The MICI is still lower than a year ago, but it increased in April, the first increase since 2020 and a sign of things to come.

Rents are another worrying aspect of the CPI. In April, they increased 4.5 percent, the biggest annual increase since 1990. Rents rose 12.6 percent in Prince Edward Island, 5.3 percent in Ontario and 6.4 percent in British Columbia.

As before the pandemic, rental markets across the country are highly competitive, in part because many people are unable to own a home, and demand is also driven by an influx of immigrants and international students. Apartment vacancies can be scarce in major cities.

“We are likely to see a continuation of rental price increases along with rising mortgage interest costs,” James Orlando, chief economic officer at Toronto-Dominion Bank, said last month in a note to investors. customers.

It’s not just mortgage interest and rents that are putting a strain on finances. Maintenance costs are rising rapidly due to supply chain disruptions in the economy. Maintenance and repair costs increased 4.4 percent over the past year, while household water, fuel and electricity costs rose 11.8 percent.

One potential mitigating factor for consumer price growth is the homeowners’ replacement cost ratio, which is a measure of depreciation or the cost of maintaining a home’s value. This is not a measure of actual expenses; Statscan does not ask homeowners if they installed a new deck in their backyard.

But to calculate depreciation, Statscan uses something real: new home prices. And during the pandemic, those prices increased, not only because of strong demand, but also because of rising prices for lumber and other building materials.

So far, homeowners’ replacement costs have risen 13 percent over the last year. Still, it is one aspect of the housing CPI that could be poised for a slowdown as the broader housing market slumps, easing pressure on inflation in that area.

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