How interest rate hikes and inflation plays out in Canada
According to Statistics Canada, higher mortgage rates are contributing to the latest high inflation data. But aren’t higher interest rates supposed to reduce inflation?
Mortgage costs have risen as interest rate increases make mortgages more expensive, and they are one of the few components of inflation data that are directly related to interest rates, according to David Macdonald, senior economist at the Canadian Centre for Policy Alternatives.
In the current environment, where interest rates are being raised rapidly, Macdonald believes that other components, such as house prices, should fall faster than mortgage rates rise.
But he claimed that’s not taking place. Instead, they are simply compensating for one another, with mortgage interest rates increasing 11.4 percent over the previous year while the index tracking home prices decreased 11.1 percent.
However, interest rate increases aren’t solely about mortgage and housing prices. According to Macdonald, higher mortgage rates will cause people to spend less on other things, lowering overall inflation. It simply hasn’t happened yet.
Which parts of Inflation affect rate hikes?
Rising interest rates have direct effects on some things, but they also have knock-on effects on others, such as spending on big-ticket items like cars.
However, the more a category is linked to external or international effects, such as extreme weather or geopolitical turmoil, the less likely it is that interest rate hikes will lower its price. Macdonald said food and gas prices, which were up 10.1 percent and 17.8 percent over last year in October, are prime examples of this.
Wages are rising as well, but not as quickly as inflation. So, why do some people believe that higher wages will exacerbate inflation when pay is already struggling to keep up?
Given that wages are not rising at the same rate as inflation, Macdonald does not believe wages are driving inflation this time around.
“Every month, workers take real pay cuts,” he said.
That is not to say that wage growth cannot be an inflation factor, but Macdonald claims there is no evidence that wages are the factor driving persistent inflation in this cycle.
Will the Bank of Canada keep increasing interest rates?
The Bank of Canada has already stated its intention to raise interest rates further, though there is some hope that the increases will not be as large as those seen earlier this year.
However, Macdonald claimed that because inflation is proving to be persistent, the bank is more likely to increase rates by more than a quarter of a percentage point in its upcoming round.
In a note to clients on Wednesday, CIBC chief economist Avery Shenfeld predicted a half-point increase from the Fed at its December interest rate announcement.
Inflation has now been 6.9 percent for two months in a row, just below previous highs.
Is inflation sticking around for the long term?
According to Macdonald, the question is not whether inflation will fall, but when and how quickly. “It is possible to control inflation,” he said, but “the control mechanism is increasingly likely to be a recession.” Every month that high inflation persists, a soft landing becomes less likely, according to Macdonald. “The longer we remain at this plateau, the more likely it is that we will enter a recession.”
When inflation slows, will prices go down too?
By definition, inflation is price growth, so even if it slows to, say, 3%, that doesn’t mean that overall prices will go down. Instead, they will rise more slowly, according to Macdonald. He believes it is unlikely that Canada will experience sustained deflation, which would mean actual price decreases and could lead to a recession.
Of course, specific prices, such as gas or housing, can and will fall, according to Macdonald. However, sustained price increases in other categories, such as food, are likely to offset those and keep price growth in the positive territory.
“The point is that these prices will not fall again.”
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