BoC Deputy Governor Gravelle says high immigration adding to housing inflation

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Home construction has not kept pace with heightened levels of population growth, driving up shelter inflation to the highest it’s been in decades, a senior Bank of Canada official said Thursday in the bank’s most explicit statement yet on how the country’s housing and immigration ambitions collide.

Speaking in Windsor, Ont., deputy governor Toni Gravelle said that high levels of immigration help keep inflation in check over the long run by expanding the work force and increasing Canada’s potential growth. But in the short term, rapid population growth without a significant increase in home building is driving up housing costs – one of the largest components of overall inflation.

“This jump in demographic demand coupled with existing structural supply issues could explain why rent inflation continues to climb in Canada. It also helps explain, in part, why housing prices have not fallen as much as we expected,” Mr. Gravelle said.

He urged all levels of government – federal, provincial and municipal – to work together to reduce barriers to home construction, which include zoning restrictions, permitting delays and a shortage of construction workers.

“Without these policy changes, we could continue to see upward pressure on the components of inflation related to rent and house prices,” he said.

Deteriorating housing affordability has become a key political issue, with opposition parties accusing the Liberal government of not doing enough to improve housing supply.

Some policy experts have also questioned whether Ottawa is adding too much demand for housing over the short term, with the population growing by around 1.2 million (or 3 per cent) over the 12 months through June. This increase was largely driven by temporary residents – such as students and workers – who tend to rent.

Mr. Gravelle, one of six members of the Bank of Canada’s governing council, was speaking the day after the bank held its policy interest rate at 5 per cent for the third consecutive decision. While the bank stood pat on Wednesday, it continued to warn that it might raise interest rates again if inflation proves stubborn.

Mr. Gravelle doubled down on this hawkish message in his speech. He said the decline in inflation in recent months and slowdown in consumer spending suggest the economy is “roughly in balance.” But he said that the bank needs to see a more sustained improvement in inflation data before ruling out further rate increases.

“While we saw some welcome improvement in inflation measures in October, we must remember it’s just one month. We need to see further progress,” he said.

The annual rate of Consumer Price Index inflation was 3.1 per cent in October, down from a peak of 8.1 per cent in June, 2022. The central bank targets 2-per-cent CPI inflation.

Housing inflation, however, continues to surge. Rent was up 8.2 per cent in October from the year before – the biggest annual increase in 40 years – while mortgage interest costs rose 30.5 per cent.

Shelter inflation is partly the result of the bank’s own rate hikes, which are pushing up mortgage costs. But it also has to do with a mismatch between housing supply and rapid population growth.

“Canada’s housing supply has not kept pace with recent increases in immigration. This is different from the United States where housing construction has been more flexible to respond to population shifts and where rent inflation is expected to continue to decline,” Mr. Gravelle said.

He noted that high immigration is not a new phenomenon; Canada has had the highest population growth in the G7 since 2016. But immigration has ramped up significantly in recent years, with the target for permanent resident admissions up 50 per cent since 2019. Because new residents tend to rent when they first move to Canada, this is affecting the vacancy rate, a key determinant of rental price pressures.

“Shortly after immigration began ramping up in 2015, Canada’s vacancy rate … started to fall,” Mr. Gravelle said. “When newcomer arrivals picked up sharply in early 2022, that steady decline in the vacancy rate became a cliff. Canada’s vacancy rate has now reached a historical low.”

Mr. Gravelle was clear that “newcomers are a positive thing” for Canada. High levels of immigration boost economic growth and help sustain Canada’s work force in the face of population aging, which will “help keep a lid on inflation pressures in the long run,” he said. Strong immigration since the start of 2022 has boosted the country’s potential output by 2 per cent to 3 per cent, he said.

Beyond housing, he said that immigration has not meaningfully added to inflation by increasing consumer spending. Newcomers have added less than 0.1 percentage points to inflation through this channel, he said.

Mr. Gravelle stopped well short of giving any recommendations on immigration policy, although he did note that only 3 per cent of non-permanent residents in Canada work in the construction sector, compared with 8 per cent of the overall population. And only 455 permanent residents came to Canada in 2022 under the federal government’s skilled trades immigration stream. The U.S., by contrast, takes in more immigrants in the construction industry.

“If you talk to developers, the smaller ones especially, they always say there’s a huge shortage of construction workers,” Mr. Gravelle said in a question-and-answer session after the speech.

“A lot of the permanent resident programs are geared on kind of a points system, and there’s a lot of weight on education. But construction sometimes needs non-educated workers, they need more blue-collar workers. So maybe the program is not geared for that.”

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In a news conference after the speech, Mr. Gravelle was asked whether the Bank of Canada’s tight monetary policy is adding to the lack of housing supply. High interest rates have made it more expensive for developers to get financing and reduced investor demand for new builds, particularly condos in major cities such as Toronto.

“We’ve seen an undersupply of homes when we’ve had low interest rates, we’ve had an undersupply of homes now when we have high interest rates. So it’s very clear that interest rates are not the only factor affecting the undersupply of homes,” Mr. Gravelle said.

Douglas Porter, chief economist at Bank of Montreal, said in a note to clients that the central bank may be playing down its role in the housing affordability problem.

“Even a cursory look at either the Bank’s own measure of housing affordability or rent inflation readily shows that there was no major issue prior to 2020,” Mr. Porter wrote. “The fire was lit by a combination of ultra-low interest rates and then the fastest population growth in 50 years.”

Most economists think interest rates have peaked and the bank will start cutting rates by the middle of next year. The bank has so far refused to endorse this view, and Mr. Gravelle’s speech contained few hints that the bank is ready to pivot toward looser monetary policy.

He said the bank needs to see a decline in core inflation, slower wage growth, falling inflation expectations and more normal corporate price-setting behaviour before considering rate cuts.

With a report from Matt Lundy