The Bank of Canada is still likely to wait until mid-year before delivering its first rate cut, despite January’s downside surprise in inflation, economists say.

Headline inflation came in below expectations with a 2.9% reading in January against expectations of 3.3% and December’s 3.4% pace. It’s the first time the headline CPI reading has fallen below 3% since June 2023 when it dipped to 2.8%.

The slowdown was driven largely by lower energy prices, specifically a 4% annual decline in gas prices, and a cooling of grocery prices, which came in at 3.4% compared to 4.7% in December.

“There is little debate on this one—it’s a much milder reading than expected, especially given the high-side surprise seen in last week’s round of U.S. inflation reports, a nice contrast,” wrote BMO chief economist Douglas Porter.

“Importantly, January can set the tone for inflation,” Porter added, “since firms often take the opportunity to adjust prices for the year in this month—and there was little sign of a big January bump this year.”

The Bank of Canada’s preferred measures of core inflation, which strip out food and energy prices, also trended downward. CPI-median eased to 3.3% (from 3.5% in December), while CPI-trim fell to 3.4% from 3.7%.

Shelter costs keeping upward pressure on inflation

Unsurprisingly, shelter costs continue to exert upward pressure on inflation, and actually rose in the month to an annualized +6.2% from +6% in December.

An ongoing supply-demand imbalance is also keeping upward pressure on rent inflation, which picked up to 7.8% from 7.5% in December. As we reported last week, average asking rents were up another 0.8% month-over-month to a record $2,200.

The Bank of Canada’s own interest rate hikes are also continuing to work their way through the economy, with the mortgage interest cost component of the CPI basket up 27.4% year-over-year.

“Shelter inflation has become the biggest hurdle preventing the Bank from cutting interest rates,” TD economist Leslie Preston wrote in a research note.

“Shelter inflation will remain sticky as higher interest rates feed through to mortgage interest costs with a lag, and undersupply of housing continues to boost rent prices,” RBC economists Nathan Janzen and Abbey Xu wrote. However, “the most likely path for inflation going forward is still lower with per-capita GDP and consumer spending continuing to decline,” they added.

What the inflation figures mean for Bank of Canada rate cuts

Most economists say the first Bank of Canada rate cut is still on track for its June 5 meeting, believing the central bank will want to see additional signs of easing inflation pressures.

“While no doubt welcome news, the Bank of Canada will likely remain cautious in the face of still-strong wage gains, firm services prices, and the reality that core inflation is still holding above 3%,” Porter wrote. “But clearly today’s result makes rate cuts much more plausible in coming months.”

RBC’s Xu and Janzen pointed out that stronger-than-expected job gains in January are another factor that will likely keep the Bank on the sidelines for now.

“A strong start to 2024 for labour markets gives the BoC more leeway to wait for firmer signs that inflation is getting back under control before pivoting to interest rate cuts,” they wrote. “As of now, our base case assumes the BoC starts to lower interest rates around mid-year.”

Earlier this month, Bank of Canada Governor Tiff Macklem told a parliamentary finance committee that the central bank doesn’t need to wait until inflation is all the way back to its neutral target of 2% before it starts cutting rates.

However, he added that “you don’t want to lower them until you’re convinced…that you’re really on a path to get there, and that’s really where we are right now.”

Following today’s inflation release, bond markets raised their rate-cuts odds slightly. They are currently pricing in a 29% chance of a quarter-point cut in March, and an 11% chance of 50 bps worth of easing by June.

This article was written for Canadian Mortgage Trends by:

Canadian home sales continued their upward trend in january as prices fell modestly

The Canadian Real Estate Association announced today that home sales over the last two months show signs of recovery. National sales were up 3.7% between December 2023 and January 2024, building on the 7.9% gain in December. The chart below shows that despite the two-month rise, sales remain 9% below their ten-year average. According to Shaun Cathcart, CREA’s Senior Economist, “Sales are up, market conditions have tightened quite a bit, and there has been anecdotal evidence of renewed competition among buyers; however, in areas where sales have shot up most over the last two months, prices are still trending lower. Taken together, these trends suggest a market that is starting to turn a corner but is still working through the weakness of the last two years.”

National gains were once again led by the Greater Toronto Area (GTA), Hamilton-Burlington, Montreal, Greater Vancouver and the Fraser Valley, Calgary, and most markets in Ontario’s Greater Golden Horseshoe and cottage country.

The actual (not seasonally adjusted) number of transactions was 22% above January 2023, the most significant year-over-year gain since May 2021. While that sounds like a resounding rise in activity, January 2023 posted the weakest transaction level in nearly twenty years.

There is pent-up demand for housing, and recent buyers are lured back into the market by the recent price decline and the fear that prices could rise significantly once the Bank of Canada starts cutting interest rates.

New Listings

The number of newly listed homes increased 1.5% month-over-month in January, although it remains close to the lowest level since last June.

“The market has been showing some early signs of life over the last couple of months, probably no surprise given how much pent-up demand is out there,” said Larry Cerqua, Chair of CREA.

With sales up by more than new listings in January, the national sales-to-new listings ratio tightened further to 58.8% compared to under 50% just three months earlier. The long-term average for the national sales-to-new listings ratio is 55%. A sales-to-new listings ratio between 45% and 65% is generally consistent with balanced housing market conditions, with readings above and below this range indicating sellers’ and buyers’ markets, respectively.

There were 3.7 months of inventory on a national basis at the end of January 2024, down from 3.8 months at the end of December and 4.1 months at the end of November. The long-term average is about five months of inventory.

Home Prices

The Aggregate Composite MLS® Home Price Index (HPI) fell by 1.2% month-over-month in January 2024, adding to the 1.1% price decline in December.

Price descents of late have been predominantly in Ontario markets, particularly the Greater Golden Horseshoe and, to a lesser extent, British Columbia. Elsewhere in Canada, prices are mostly holding firm or, in some cases (Alberta and Newfoundland and Labrador), continuing to rise.

The Aggregate Composite MLS® HPI was up 0.4% year-over-year in January 2024, similar to readings over the past six months.

Bottom Line
Sales in December and January generally run at about half the peak spring season pace. That could be especially true this year, with interest rates likely to begin falling by mid-year. A strong housing rebound is coming. Housing markets have bottomed, buyer sentiment is improving and fixed mortgage rates have started declining.

Housing markets in Toronto, Vancouver and Montreal are relatively balanced again, and with the spring season, we will see a rise in new listings.

In other news, the inflation data released yesterday in the US were higher than expected, pushing rate-cut forecasts further out. With the strength in the US economy, the 5-year government of Canada bond yield has quietly risen more than 50 basis points this year.

Canada’s Housing Minister, Sean Fraser, said he expects the fall in interest rates this year to encourage builders to ramp up their activity, helping to alleviate some of the country’s crunched housing supply. At a news conference yesterday, the minister said, “My expectation is if we see a dip in interest rates over the course of this year, a lot of the developers that I’ve spoken to will start those projects that are marginal today.”

Sean Fraser, asked whether he’s concerned that Bank of Canada rate cuts will unleash pent-up demand and higher home prices, said lower borrowing costs should also lead to an increase in supply. Fraser said whatever happens with rates, the government’s course of action will remain the same. “We need to do everything we can as quickly as we can to build as many homes as we can. And that’s going to be true today and six months from now, regardless of what may happen in the interest rate environment that we’re dealing with.”

At a news conference last week, Bank of Canada Governor Tiff Macklem said that while he’s heard from developers who’ve indicated higher rates are delaying projects, lowering rates would have a more significant impact on demand.

“It’s very clear in the data that the effects of interest rates on demand are much bigger than those on supply,” he told reporters.

When the Canada Mortgage and Housing Corporation (CMHC) announced that Canada would need an extra 3.5 million homes by 2030 to keep up with demand, the figure was already staggering.

But a new report from CIBC deputy chief economist Benjamin Tal suggests the housing supply gap is even worse than first thought.

In his research note entitled, ‘The housing crisis is a planning crisis,’ Tal argues that the total number of homes needed by 2030—above and beyond the current pace of construction—is actually closer to five million homes.

He said the discrepancy is due to a lack of proper planning around population, with growth targets consistently falling short of reality. The biggest reason for this, he explains, is an under-estimate of non-permanent residents, which he says make up more than 90% of the forecasting gap.

“You cannot build an adequate supply of housing for population growth that you fail to forecast,” Tal wrote.

“That significant forecasting/planning gap is a direct result of the fact that currently there are no credible forecasts, targets, or capacity plans across governments for non-permanent residents—the population which accounts for the vast majority of the planning shortfall,” he added. “That must change.”

Can’t plan for what’s not in the plan, Tal says

Tal notes that the planning process for municipalities to accommodate future growth is a lengthy process, taking up to a decade to “identify, service and allocate land for housing, then [to] auction that land for developers to construct and sell housing units on.”

“Therefore, accurate forecasts of population growth are key for adequate housing supply.”

But past forecasts have regularly missed the mark.

“That was a big miss,” Tal said. “The reality is that today municipalities are facing 1.4
million more people than they were told they needed to plan for— in total that’s a shortfall of almost three years of housing supply.”

Even more recent population forecasts have failed to keep up with the rapid pace of population growth, with Statistics Canada’s August 2003 projections falling short by roughly 700,000 people.

What can be done?

Last month, Immigration Minister Marc Miller announced a national cap on the number of international students accepted into the country, which is expected to reduce intake by about 35% to a total of 364,000 students in 2024.

While Tal called the measure a “bold move in the right direction,” he says more still needs to be done.

“Even if the cap works as designed, the strong pace of growth of other non-permanent residents would keep Canada’s population growth closer to 2% annualized growth,” Tal says, which is above CMHC’s current 1.5% annual growth projections for the next seven years, or about six million additional international arrivals beyond what is forecast.

What is most needed, Tal argues, is “meaningful forecasting and integrated planning” that is applied to all permanent and temporary visa approvals.

“A full matrix of targets by application type and year, as exists for permanent residents, is an essential step to assist planning at all levels, for the Ministry of Housing, provinces/territories, municipalities, as well as for the development industry,” Tal says. “Transparent, timely, and vetted [forecast] sourcing is key.”

This article was written for Canadian Mortgage Trends by: