Mortgages and Their Role in Fueling Inflation

Kandice Martinez
November 10, 2023

Recently  Canada’s central bank raised interest rates once more due to the lingering impact of high inflation. This has brought into focus the intriguing link between mortgages and escalating consumer prices.

In May, the Consumer Price Index (CPI) for Canada recorded a 3.4% surge. However, some analysts suggest that if mortgage considerations were excluded, the inflation rate would align more closely with the bank’s 2% target.

It’s not accurate to lay the blame squarely on mortgages for the inflation spike. However, this situation underscores the significant influence real estate holds within Canada’s economic structure. Cost-of-Living is a significant challenge for policy makers tasked with managing inflation.

The Mortgage-Inflation Puzzle

Mortgages are  highly sensitive  to interest rate fluctuations. This poses an intriguing situation: the very measures the Bank of Canada implements to curb inflation might inadvertently be increasing it. .

The interest rate? – what exactly are you talking about here? on Canadian mortgages marked a staggering 29.9% annual jump in May, far surpassing general inflation trends.

When asked about this dynamic, the Bank of Canada Governor Tiff Macklem acknowledged the strong interrelation between mortgage costs sensitive to rates and inflation. He explained that eliminating mortgages from the inflation equation is complex. By removing falling cost factors only rising ones remain, thus skewing the perspective.

Chief Economist at TD Bank, Beata Caranci, agreed with or echoed Macklem’s viewpoint, and emphasised that mortgage costs are merely one among many diverse components assessed when choosing a course of action to manage inflation.

Real Estate’s Pivotal Role

Victor Tran, a mortgage specialist at RATESDOTCA, believes assessing inflation without considering mortgages is an oversimplification. The prominent role of the real estate sector in Canada’s economic matrix makes it a critical for the Bank of Canada’s attention, possibly even more so than its counterparts in other nations.

Tran emphasised Canada’s substantial reliance on real estate, labelling it as an indispensable sector. Many experts speculate that the considerable surge in mortgage interest rates  could be a deliberate strategy by the central bank reacting to the unexpected resurgence of the housing market earlier this year.

Given the steep rise in interest rates, Tran wasn’t surprised about mortgages swaying inflation. Caranci also inferred that the bank’s intent is to rein in consumer expenditure, a key inflation driver, by amplifying the burden of mortgage repayments on homeowners.

Demand, Supply, and Inflation

Experts predominantly  attribute Canada’s soaring housing expenses to an insufficient supply. Macklem recently linked heightened immigration rates to mounting housing demand, exerting further pressure on an already constrained supply and consequently boosting prices.

Tran interpreted these comments as a subtle nudge towards federal policies expediting immigration. The Bank of Canada, in its recent rate decision statement, highlighted the increased activity in the housing sector, mentioning that the growth in new real estate listings and constructions is not keeping pace with demand.

Jim Stanford, Economist with the Centre for Future Work, suggested that surging interest rates are dampening enthusiasm for new housing projects. Tran also touched upon potential cascading effects of rate hikes on housing developments.

Seeking Solutions

Resolving the housing cost dilemma is beyond the sole purview of the Bank of Canada, as per Tran, necessitating a joint strategy with other regulatory bodies, insurance entities, and government institutions..

While Tran believes governments can enforce stringent banking regulations to decelerate the housing market’s pace, he also recognizes the intricacies involved, given the immense interest vested in real estate and the financial gains at stake.