The May consumer price index (CPI) rose 3.4 per cent year over year, which was a big drop from the 4.4 per cent year-over-year number in April, but that doesn’t tell the real story.
Not surprisingly, there is a component of the CPI that is still showing significant inflation. The mortgage interest cost index was up a massive 29.9 per cent year over year. You would not be alone if you looked at that number and thought, “What the hell do they expect?” Shockingly, as sure as one plus one equals two, mortgage expenses go up for a good percentage of Canadians when the Bank of Canada raises interest rates.
When it comes to mortgage interest costs, a Bank of Canada interest rate hike is like suggesting that someone with high blood sugar should eat a sugar cube to bring their blood sugar level down.
The logic for the Bank of Canada to raise interest rates is to tame inflation and bring it back to two per cent. Of interest, their target for the longest time was between one per cent and three per cent. Of course, we can see that a meaningful component of CPI works diametrically opposed to the raise-rates-to-lower-inflation focus. Given this anomaly with mortgage interest costs, surely it makes sense to view CPI with this component excluded.
In May, if the mortgage interest cost index is removed, the year-over-year CPI is 2.5 per cent, very close to the target inflation rate. I repeat: the CPI excluding mortgage interest is 2.5 per cent. One year ago, this all-in CPI rate was 7.7 per cent. It has declined by 5.2 percentage points in one year. Whether it is from central banks hiking interest rates, or simply a normalization of inflation, after the COVID-19 roller-coaster on global economies, this a significant shift any way you look at it.
I am always told that hiking interest rates should help tame inflation, but it takes time, since it has a lagged impact. If the CPI is now 2.5 per cent and the sizable interest rate hikes are having a lagged impact, doesn’t this suggest that we are done taming inflation with interest rate hikes? After all, the Bank of Canada just did another interest rate hike in early June. How much more lagged impact is already ahead of us if inflation is already at 2.5 per cent?
I know that it isn’t that simple. You can slice and dice inflation a number of different ways, and if you focus on expected salary increases or food prices, one can make a case that higher interest rates are required to slay the inflation beast.
I simply don’t buy it.
All these factors are included in the 2.5-per-cent CPI number. The only item removed is the one that you know will go up if the Bank of Canada raises rates further.
Many economists expect the Bank of Canada to raise rates another quarter-point in July. “Absent a large downside surprise from those (upcoming) data releases, we continue to expect the bank to hike the overnight rate by another 25 basis points in July, before stepping back (to) the sideline for the rest of this year,” Royal Bank of Canada economist Claire Fan said.
The Bank of Canada justified its June rate hike in part by pointing to the slight rise in the CPI in April to 4.4 per cent from 4.3 per cent.
At 2.5 per cent today (excluding mortgage interest costs), and with the central bank having already raised rates by 4.5 percentage points in just a 17-month period starting in January 2022, enough is enough. The Bank of Canada hasn’t had this large an interest rate increase since the late 1980s. From February 1987 to June 1990, the prime rate went up 5.5 percentage points. Shockingly, the prime then dropped 9.25 percentage points over the following three-and-a-half years.
Higher interest rates have already had a big impact on inflation and will continue to have an impact for some time to come. It is time for the Bank of Canada to stop raising rates now.
Reproduced from Financial Post, June 28, 2023 .
