Shelter prices increased 6.5% year over year in March, rising at the same rate as in February.
The mortgage interest cost index rose 25.4% y/y in March, following a 26.3% increase in February. The homeowners’ replacement cost index, which is related to the price of new homes, declined less in March (-1.0%) compared with February (-1.4%) on a year-over-year basis.

Rent prices continued to climb in March, rising 8.5% year over year, following an 8.2% increase in February. Among other factors, a higher interest rate environment, which can create barriers to homeownership, puts upward pressure on the index.

Prices for services (+4.5%) continued to rise in March compared with February (+4.2%), driven by air transportation and rent. This outpaced price growth for goods (+1.1%), which slowed compared with February (+1.2%) on a yearly basis.

On a seasonally adjusted monthly basis, the CPI rose 0.3% in March.

Most importantly, the three-moving average of all core measures of Canadian inflation fell to below 2%, the Bank of Canada’s target inflation level. Governor Tiff Macklem got exactly what he was hoping for: Further confirmation that core inflation was falling within the target range.

Shelter remains the single most significant contributor to total inflation. Excluding shelter, inflation is tracking just 1.5% and has been below the central bank’s 2% target for most of the past six months. This has slowed economic activity, reducing consumer discretionary spending and making it more difficult for businesses to raise prices. Once interest rates fall, mortgage interest costs—a large component of shelter costs—will start falling.

The three-month annualized rates of the Bank of Canada’s core-median and trim indicators slowed to just 1.3% (see chart below), and the average year-over-year rates are down a tick to 3.0%. According to the economists at Desjardins, “the share of components in the CPI basket that are rising more than 3%, an indicator closely watched by Governor Macklem, is down to 38% from 41%. And the share of components showing price growth of less than 1% is up to 44% from 38% in February. Both suggest that the breadth of inflationary pressures is becoming more consistent with the Bank of Canada’s 2% target”.

We will see the April inflation data on May 21, before the next BoC decision date. While gasoline prices have continued to rise this month, so far, the gain has been more muted than in March. With any luck, today’s data will set the stage for the first BoC rate cut in June.

There is significant pent-up demand for housing owing to rapid population growth and first-time homebuyers’ fears that prices will rise sharply once the Bank of Canada cuts interest rates. Moreover, Ottawa has been handing out goodies for first-time buyers–leaking what’s to come in the April 16 federal budget. The Finance Minister has already announced the resumption of 30-year amortization on insured mortgages for first-time buyers of new construction. While this is less than meets the eye, in that pre-sales typically require a 20% deposit, the homebuilders’ association is pretty excited.

In addition, Ottawa has eased restrictions on the RRSP Home Buyers’ Plan, allowing F-T buyers to withdraw $60,000–up from $ 35,000 (never mind that the $35K ceiling is hardly ever broached)–with 5 years until repayments must begin, up from two years.

Ottawa is also providing assistance to at-risk homeowners, telling lenders to work with these households to lower payments “to a number they can afford, for as long as they need to” by allowing longer remaining amortizations. The Department of Finance is encouraging lenders to begin working with these at-risk households two years before scheduled renewals. The unintended consequences of this could be significant. For example, what happens to the mortgage-backed securities market and other investors in mortgages? Also, this reduces competition by discouraging refinancings and could raise the cost of borrowing for all participants.

Ottawa has never been very good at considering the second-order effects of their actions. A case in point is the decision to markedly increase immigration (for lots of good reasons) without considering where all of these new people would live. This has led to a massive housing shortage and the least affordable housing in Canadian history. Now that Trudeau’s approval ratings have suffered, they are scrambling to remediate, but increasing demand for housing is obviously not the answer.

There will be more news on Tuesday when I dissect the federal budget’s housing initiatives. The more government money spent, the more money borrowed, which will only raise interest rates from what they will otherwise be.

Back to the March data, national home sales edged up a mere 0.5% month-over-month, although activity rose 1.7%. That was a much smaller gain than those recorded in the previous two months, although a part of that does reflect a mostly inactive market during the Easter long weekend.

The number of newly listed homes declined by 1.6% month-over-month in March. “While the official March monthly numbers were quite flat, anecdotal evidence from late last month and early April suggests activity is ramping up,” said Larry Cerqua, Chair of CREA.

With sales edging up and new listings falling in March, the national sales-to-new listings ratio tightened to 57.4%. The long-term average is 55%. A sales-to-new listings ratio between 45% and 65% is generally consistent with balanced housing market conditions, with readings above and below this range indicating sellers’ and buyers’ markets, respectively.

At the end of March, there were 3.8 months of inventory nationwide, unchanged from the end of February. The long-term average is about five months of inventory.

New listings rose sharply in late March and early April–good news on all fronts.

The actual national average home price in March was up 2% year-over-year from a markedly depressed level. The MLS Home Price Index was roughly unchanged, down markedly from its early 2022 peak when the central bank’s overnight policy rate was a mere 25 basis points before they started hiking rates in March, two years ago.

With pent-up demand for housing rising with every rent increase, the spring housing season is likely to be robust, even before the central bank cuts interest rates. We believe the BoC will begin reducing the policy rate in June or July, depending on the next two CPI reports. March inflation data will be released on Tuesday (a big day for economic news), and April data will come out on May 21st. The next Bank of Canada decision date is June 5th.

The Bank also noted that Q4 GDP growth came in stronger than expected at 1.0% but was well below potential growth, confirming excess supply in the economy.

Employment continues to rise more slowly than population growth. During the press conference, Governor Macklem said it was too early to consider lowering rates as more time is needed to ensure inflation falls towards the 2% target.

The Bank of Canada expects that progress on inflation will be ‘gradual and uneven.’ “Today’s decision reflects the governing council’s assessment that a policy rate of 5% remains appropriate. It’s still too early to consider lowering the policy interest rate,” Macklem said in the prepared text of his opening statement. The Bank is pushing back on the idea that rate cuts are imminent.

High interest rates are dampening discretionary spending for households renewing mortgages at much higher monthly payments. As the economy slows in the first half of this year, the BoC will signal a shift towards easing. This could happen at the next meeting on April 10, when policymakers update their economic projections. This could prepare markets for a June rate cut.

“We don’t want to keep monetary policy this restrictive longer than we have to,” Macklem said. “But nor do we want to jeopardize the progress we’ve made in bringing down inflation.”

The Monetary Policy Report (MPR) detailed a slowdown in global economic growth “as past increases in policy rates and the recent surge in global bond yields weigh on demand.” Continued increases in longer-date bond yields reflect the stronger-than-expected growth in the US, where the Q3 economic growth rate, released tomorrow, is expected to be a whopping 5%. Ten-year yields in the US have risen to nearly 5%, boosting fixed mortgage rates in Canada.

Oil prices are higher than was assumed in the July MPR, and the war in Israel and Gaza is a new source of geopolitical uncertainty.

The Governing Council said that past increases in interest rates are slowing economic activity in Canada and relieving price pressures. “Consumption has been subdued, with softer demand for housing, durable goods and many services. Weaker demand and higher borrowing costs are weighing on business investment. The surge in Canada’s population is easing labour market pressures in some sectors while adding to housing demand and consumption. In the labour market, recent job gains have been below labour force growth, and job vacancies have continued to ease. However, the labour market remains on the tight side, and wage pressures persist. Overall, a range of indicators suggest that supply and demand in the economy are now approaching balance.”

Economic growth in Canada averaged 1% over the past year, and the Bank forecasts it will continue to be weak for the next year before increasing in late 2024 and through 2025. The Bank is not forecasting a recession over this period. “The near-term weakness in growth reflects both the broadening impact of past increases in interest rates and slower foreign demand. The subsequent pickup is driven by household spending as well as stronger exports and business investment in response to improving foreign demand. Spending by governments contributes materially to growth over the forecast horizon. Overall, the Bank expects the Canadian economy to grow by 1.2% this year, 0.9% in 2024 and 2.5% in 2025.”

In today’s MPR, CPI is expected to average about 3.5% through the middle of next year before gradually falling to the 2% target level in 2025. “Inflation returns to target about the same time as in the July projection, but the near-term path is higher because of energy prices and ongoing persistence in core inflation.”

The hawkish tone of the final paragraph of today’s press release is noteworthy. The Bank does not want to boost interest-sensitive spending, such as housing and durable goods purchases, by assuring markets that its next move will be a rate cut. Instead, the Bank said, “Governing Council is concerned that progress towards price stability is slow and inflationary risks have increased, and is prepared to raise the policy rate further if needed. The Governing Council wants to see downward momentum in core inflation. It continues to be focused on the balance between demand and supply in the economy, inflation expectations, wage growth and corporate pricing behaviour. The Bank remains resolute in its commitment to restoring price stability for Canadians.”

Nothing was surprising in today’s report. The slowdown in economic activity since late last year has dramatically reduced excess demand. The output gap–the difference between the actual growth in GDP and its potential growth at full employment–is essentially closed, suggesting that demand pressures have been easing. They had previously expected the output gap to close in early 2024.

Of concern to the Bank is that inflation remains above their 2% target in the face of increased global risks of higher inflation. Upside risks to inflation include elevated inflation expectations of households and businesses, growing extreme weather events, and heightened geopolitical uncertainties including the Israel-Hamas war.

Price gains in energy and shelter — upward pressures on inflation — are “anticipated to be partially offset by the easing of excess demand, weaker pressure from input costs and further disinflation in globally traded goods,” the Bank said.

“Ongoing excess supply in the economy moderates price inflation, helps ease inflation expectations and encourages businesses to gradually return to more normal pricing behaviour.”

Canada’s households are more indebted, on average, than their US counterparts and their shorter-duration mortgages roll over faster. That makes the Canadian economy more sensitive to higher rates and is one reason the Bank of Canada first declared a pause in January, well before the US Federal Reserve. The central bank’s next decision is due Dec. 6, after two releases of jobs data, October inflation numbers and third-quarter gross domestic product figures. I expect the Bank to pause rate hikes for the next six to nine months. When they finally begin to ease monetary policy, they will do so gradually, taking the overnight rate down to roughly 4% by the end of next year.