Factors in Canada's frothy real-estate market pushed inflation up in May

The base-year effects are beginning to pull away in last month's numbers, leaving economists cautious

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Statistics Canada’s measure of what it would cost homeowners to replicate their current living conditions increased at the fastest rate in 34 years in May, sparking a jump in the Consumer Price Index that caused some economists to wonder if the Bank of Canada might be losing its grip on inflation.


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The CPI rose 3.6 per cent from May 2020, the biggest increase in a decade and well outside the central bank’s comfort zone of one per cent to three per cent, Statistics Canada reported on June 16.

It was the second consecutive month that the CPI grew at an annual rate faster than three per cent, prompting questions about whether underlying inflation pressure might be stronger than the Bank of Canada assumes in its forecasts. “How long does this persist?” Benjamin Reitzes, an economist at the Bank of Montreal, asked in an interview after Statistics Canada published its latest inflation figures.

“It’s well early to freak out,” said Reitzes, but he conceded that the May figures argue for more caution going forward.

For much of the last decade, economists were puzzled by why there was so little inflation, at least as measured by indicators such as the CPI, which aggregates the prices of about 700 goods and services. And then a year ago, deflation was the bigger worry, as the COVID-19 recession caused the year-over-year rate of change to contract for a brief period of time. That weakness explains much of the CPI’s startling jump this spring, but those so-called base effects were starting to fade last month, Statistics Canada said.

“Unlike March and April 2021, when most of the year-over-year gains in the CPI were characterized by the large upward base-year effects caused by price declines falling out of the 12-month movement, base-year effects affected the 12-month price movement for only a few key goods and services in May 2021,” the agency said, adding that shelter costs and passenger vehicles were the biggest drivers of inflation last month.


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Statistics Canada put a spotlight on housing, as the homeowners’ replacement index shot up 11.3 per cent, the biggest yearly increase since 1987. That’s noteworthy because it suggests that record house prices are starting to show up in the CPI indirectly. Statistics Canada disregards the housing market in its inflation calculations because it considers property an asset, not a good that is purchased on a regular basis. Instead, it measures “shelter” costs by recording such things as changes in rents and mortgage rates.

In May, the shelter basket was influenced by competing forces of upward and downward pressure. The measure accounting for mortgages dropped 8.2 per cent, overall shelter costs grew 4.2 per cent.

“I expect a persistent, positive contribution from housing into the CPI for at least the next few months and probably into 2022, as well,” said Reitzes.

Benjamin Tal, deputy chief economist at the Canadian Imperial Bank of Commerce, said he pays little attention to the housing market when thinking about inflation because he finds there is a weak correlation between the two. He said there are more important forces at work at the moment, such as the semiconductor shortage that has crippled automobile production, making it difficult for factories to keep up with demand.

I expect a persistent, positive contribution from housing into the CPI for at least the next few months and probably into 2022

Benjamin Reitzes

“We have supply-chain issues, namely inventories are down because of COVID and other bottlenecks,” Tal said.

The durable goods category rose 4.4 per cent year over year, the quickest since 1989. Furniture prices in May increased nearly 10 per cent, with upholstered furniture shooting up more than 10 per cent.


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Vehicles contributed the most to the increased prices of durable goods, jumping up five per cent year over year, another record-setter from when the passenger vehicle index came into existence in September 2016.

Despite the CPI growth that might make Bank of Canada Governor Tiff Macklem tug at his collar a bit, the real number economists should focus on is the two-year change, said Reitzes.

“There’s so much noise out of the pandemic,” he said. “But if you adjust for the pandemic, take the yearly change from years ago, you realize that the 24-month change is 1.6 per cent. So we still have relatively low inflation.”

The Bank of Canada sets interest rates to keep the annual change in the CPI around two per cent. Macklem has insisted that the current burst of inflation will pass, and then things will get back to normal. There still are more than 500,000 fewer workers in the economy than there were before the pandemic, suggesting overall conditions remain weak.

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Tal and Reitzes said they are in a “wait-and-see” mode. Both expect June numbers will be even less influenced by base-year effects, suggesting the next report could give a truer read of the situation. Tal said he will be watching out for a rise in wages, indications of whether recent price increases are hurting demand, and continued supply-chain bottlenecks as the country heads into a vaccinated summer.

“The (ultimate) point I’m making is that nobody knows where inflation will be six months from now and when I say nobody, I include the Bank of Canada,” Tal said. “It’s simply something we cannot predict because we haven’t seen this kind of situation in a long, long time.”

Financial Post

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