What the Latest Consumer Price Index Means for Mortgage Rates

Last Friday Statistics Canada released its latest Consumer Price Index (CPI), which shows that prices have now increased by an average of 1.5% over the most recent twelve months.

The latest CPI result came in higher than the 1.2% increase we saw in December and higher too than the 1.3% increase the consensus was expecting for the month of January, but it was still well below the Bank of Canada (BoC) target rate of 2%. Meanwhile, core inflation, which strips out the CPI’s more volatile inputs like food and energy prices, rose by 1.4% (up from 1.3% in December).

Interestingly, seven of the eight major price components that make up the CPI rose in January, with shelter (+2.1), transportation (+2.0%), and food costs (+1.1%) leading the way.

This CPI uptick was welcome news for our central bank. The BoC has grown increasingly concerned about our rate of inflation because it has languished below the Bank’s target rate for more than two years now, essentially because there is too much slack in our economy.

The BoC recently indicated that it would consider lowering its overnight rate in an effort to help bring our excess economic capacity back online, but this would only be done as a last resort. The Bank is still concerned about our household borrowing rates, which have slowed recently but might reaccelerate in response to a rate cut.

Thus far, the Bank has been able to use a change in the language it uses to lower expectations on the timing of future rate increases, and this has helped push the Loonie lower against the Greenback. A cheaper Loonie helps stimulate our economy in many of the same ways that a BoC rate cut would, only in a more narrowly targeted way and to a lesser overall degree. Think of the falling Loonie as a form of ‘rate-cut lite’.

Timing is the BoC’s biggest challenge now, as it often is. The Bank is hoping that the positive effects of the cheaper Loonie will permeate through our economy before continued disinflation translates into outright deflation. (As a reminder, disinflation is a reduction in the rate at which average prices are rising, while deflation happens when average prices are actually falling.)

We don’t want to make too much of one month’s CPI report, but an acceleration in our average prices last month may be an early signal that our average inflation rate is coming off the bottom.

While it may sound counterintuitive that a central bank charged with maintaining price stability would be relieved to see an increase in average prices, price stability is a two-sided coin. Falling prices must be monitored with the same caution as rising prices, and the latter have been of greater concern to the BoC for some time now.

Five-year Government of Canada (GoC) bond yields rose by four basis points last week, closing at 1.69% on Friday. Borrowers who are putting down at least 20% on the purchase of a new home should be able to find a five-year fixed rate in the 3.09% range and borrowers who are putting down less than 20% can now find five-year fixed rates for as low as 3.04% (albeit with more limited terms and conditions and the added cost of high-ratio mortgage insurance).

Five-year variable-rate mortgages are offered at rates as low as prime minus 0.65%, which works out to 2.35% using today’s prime rate of 3.00%.

The Bottom Line: Our January CPI report showed that average prices rose by 1.5% over the past month. This development further diminishes the slim chance that the BoC will cut its overnight rate any time soon, but neither should it materially increase the likelihood that the Bank will raise our short-term borrowing rates any time in the near future.