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Economists expect inflation eased in January, but housing still 'thorn' in BoC's side

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As the Bank of Canada waits for the right moment to start cutting interest rates, some economists are arguing that its decision shouldn't hinge on the housing market.

Canada's inflation rate has edged up and down over the last several months after dropping from its 2022 highs as global price pressures fade and the economy cools.

Statistics Canada is set to release its January consumer price index report on Tuesday and forecasters expect Canada's inflation rate fell. RBC, CIBC and TD all project the annual rate eased to 3.2 per cent, down from 3.4 per cent in December.

Nathan Janzen, RBC's assistant chief economist, says the slowdown was likely driven by energy and food prices.

"Gasoline prices were lower than a year ago in January and food price growth probably continued to slow on a year over-year-basis," he said.

"I think the attention will be more focused on the other components of CPI, just watching for signs that broader inflation pressures are continuing to slow, if only at a gradual pace."

As high borrowing costs cause consumers and businesses to pull back on spending, inflation is expected to slowly inch closer to the two per cent target by the end of the year.

But unlike what's typical when interest rates rise, the housing market won't be helping the economy slow. Economists widely expect shelter costs to continue soaring this year, making the Bank of Canada's job that much harder.

"Food and housing are really the ones that are growing at an uncomfortable level and still (remain) the thorn in the side of Bank of Canada," said James Orlando, TD's director of economics.

In December, shelter costs were up six per cent from a year ago and grocery prices rose 4.7 per cent annually.

Orlando argues the central bank shouldn't hold off on cutting interest rates while waiting for the housing market to slow, given that high interest rates aren't going to help get those costs down.

In a report on Friday, CIBC also noted the central bank isn't well-positioned to help ease shelter costs.

"Planned reductions in the inflow of foreign students, and perhaps other (government) measures still to come, might be more potent than high interest rates in calming rising rents, while the mortgage interest cost component would be helped by Bank of Canada rate cuts," the report said.

The Bank of Canada has recently emphasized the outsized role housing has played in propping up inflation. At the interest rate announcement last month, when it opted to continue holding its key interest rate at five per cent, it noted shelter costs are now the primary driver of above-target inflation.

RBC says mortgage interest costs — which are driven by the central bank's rate hikes — account for a quarter of inflation. If those costs were removed, the bank says inflation would be in the one to three per cent target range.

The Canadian Real Estate Association recently reported home sales picked up in January for a second month in a row. And while prices fell, the association said rising activity suggests the market is starting to "turn a corner."

The prospect of a rebound is clearly on the Bank of Canada's mind. In its summary of the deliberations leading to its Jan. 24 rate decision, the central bank said its governing council is concerned that a housing market rebound this spring could keep inflation above its target, even as price growth elsewhere in the economy eases.

Orlando said if the central bank were to cut rates too early, it could cause extra froth in the housing market. But he said says the Bank of Canada should still focus on how the economy overall is faring, rather than fixating too closely on shelter.

"Are you willing to sacrifice the rest of the economy, to bring down shelter inflation? And our analysis shows that you're not even going to be able to bring down shelter inflation, no matter what you do with interest rates," he said.

Orlando said to get to two per cent inflation, prices for other goods and services would essentially have to stop growing to compensate for high housing costs.

In a recent speech, governor Tiff Macklem conceded that the central bank can't do much when it comes to housing costs.

“Housing supply has fallen short of housing demand for many years. There are many reasons why — zoning restrictions, delays and uncertainties in the approval processes, and shortages of skilled workers. None of these are things monetary policy can address,” Macklem said on Feb. 6.

This report by The Canadian Press was first published Feb. 19, 2024.

This is a corrected story. A previous version misspelled Nathan Janzen's last name. 

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