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

As the Bank of Canada contemplates potential interest rate cuts, some economists believe that the fate of the housing market should not be the sole determinant of this decision.

Over the past months, Canada's inflation rate has experienced fluctuations after a decline from its peak in 2022, attributed to diminishing global price pressures and a cooling economy.

Today, Statistics Canada is scheduled to unveil its January consumer price index report, with predictions pointing towards a decrease in Canada's inflation rate. Major financial institutions, including RBC, CIBC, and TD, forecast a dip to 3.2 per cent from December's 3.4 per cent. Nathan Janzen, RBC's assistant chief economist, attributes this slowdown to lower energy and food prices, particularly noting a decline in gasoline prices compared to the previous year.

Despite expectations that inflation will gradually approach the two per cent target by year-end due to reduced spending driven by high borrowing costs, the housing market remains an obstacle. Economists anticipate persistent increases in shelter costs throughout the year, posing a challenge for the Bank of Canada.

James Orlando, TD's director of economics, highlights that food and housing are growing uncomfortably, remaining the "thorn in the side of Bank of Canada." Shelter costs surged by six per cent year-over-year in December, and grocery prices increased by 4.7 per cent annually.

Orlando argues against delaying interest rate cuts, emphasizing that the housing market's slowdown is not guaranteed, and high interest rates won't necessarily alleviate the rising costs. CIBC, in a recent report, also suggests that the central bank may not be well-equipped to address soaring shelter costs. It identifies planned reductions in the inflow of foreign students and potential government measures as potentially more effective in calming rising rents.

The Bank of Canada has acknowledged the prominent role of housing in driving inflation, with shelter costs now identified as the primary contributor to above-target inflation. RBC estimates that mortgage interest costs, influenced by the central bank's rate hikes, constitute a quarter of inflation. The removal of these costs would place inflation within the one to three per cent target range.

The Canadian Real Estate Association reports a two-month consecutive rise in home sales, signaling a potential market turnaround, although prices have experienced a decline.

The central bank is wary of a housing market rebound affecting inflation levels, but economists like Orlando emphasize the need for a broader focus. While acknowledging the potential risk of an early rate cut leading to increased housing market activity, Orlando contends that sacrificing the overall economy to combat shelter inflation may not be a prudent strategy.

Governor Tiff Macklem recently acknowledged the limitations of monetary policy in addressing housing costs, citing longstanding issues such as zoning restrictions, approval process delays, and shortages of skilled workers. Macklem emphasized that these are challenges beyond the scope of monetary policy interventions.



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