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A house for sale in Ottawa on June 15.Spencer Colby/The Globe and Mail

Canada’s housing market is plunging as higher interest rates scare off potential buyers. Even so, the effects of the slowdown are not showing up in the country’s red-hot inflation numbers.

As the real-estate sector cools, the cost of owning or renting a home is climbing rapidly in the consumer price index (CPI), Statistics Canada’s go-to measure of inflation. The cost of shelter rose 7.4 per cent in April, the largest annual gain since 1983.

The increase can be pinned on several factors, from rising home energy costs to how Statscan measures the price changes facing homeowners. Making matters tougher, the housing sector is likely to continue putting upward pressure on inflation – in part, because mortgage rates are rising to multiyear highs and rents are soaring in urban centres.

Statscan publishes its next inflation report on Wednesday. The median estimate from economists is that annual inflation hit 7.3 per cent in May – rising from 6.8 per cent in April – which would be the highest in nearly four decades.

Shelter, the largest component of CPI, with a weighting of 30 per cent, will play an outsized role in the trajectory of inflation, which the Bank of Canada is trying to tamp down through its quickest pace of monetary policy tightening in decades. Already, the central bank’s rate hikes have led to lower sales volumes and falling prices in some large housing markets.

Commercial rent prices are rising, and many small businesses are finding it hard to keep up

“It seems like every month there’s a different source of new inflationary pressures that are popping up, and the latest is that people who are now renewing their mortgages that maybe they took out three or five years ago are paying more in mortgage interest payments than they were previously,” said Royce Mendes, head of macro strategy at Desjardins Securities.

“Obviously, this is now another source of inflation for Canadians to contend with.”

The run-up in housing costs is something of a reversal, so far as CPI is concerned. Earlier in the pandemic, as home prices were sky-rocketing across the country, Statscan’s calculation of shelter inflation was subdued. That led to criticism – often from federal opposition parties – that the CPI failed to capture Canadians’ true costs.

Homeownership is a controversial aspect of inflation, because unlike consumable goods – say, a bag of groceries – real estate is an asset. Statscan aims to track the cost of using a home, rather than acquiring it, and excludes down payments from its calculations.

“CPI does not include the purchase of a property, because in this case, we don’t consider a house a consumer good,” Heidi Ertl, director of the consumer-prices division at Statscan, told The Globe last year. “We consider it an asset.”

The mortgage interest cost index (MICI) is a component of CPI that’s directly affected by housing market conditions. However, it tracks interest costs rather than total mortgage payments (principal and interest).

Early in the pandemic, mortgage rates fell to record lows, fuelling the record-setting stretch of home transactions that followed. But even as rock-bottom rates drove up home prices – for some, to unaffordable levels – the MICI began to fall sharply, acting as a drag on inflation.

That’s starting to change. Mortgages are now priced at their highest rates in years, with some major lenders offering five-year fixed rates in excess of 5 per cent. The MICI remains lower than a year ago, but it ticked up in April – the first increase since 2020 and a sign of things to come.

Rents are another troubling aspect of CPI. In April, they rose 4.5 per cent, the largest annual increase since 1990. Rents were up 12.6 per cent in Prince Edward Island, 5.3 per cent in Ontario and 6.4 per cent in British Columbia.

Much like before the pandemic, rental markets nationwide are highly competitive, in part because many people are priced out of homeownership, with demand also bolstered by an influx of immigrants and international students. Apartment vacancies can be meagre in major cities.

“We are likely to see a continuation of rent price increases alongside rising mortgage interest costs,” James Orlando, director of economics at Toronto-Dominion Bank, said last month in a note to clients.

It’s not only mortgage interest and rents that are putting finances under strain. Upkeep costs are rising quickly, owing to supply-chain disruptions in the economy. Maintenance and repair costs are up 4.4 per cent over the past year, while water, fuel and electricity costs for the home have jumped 11.8 per cent.

A potential mitigating factor for consumer price growth is the homeowners’ replacement cost index, which is a measure of depreciation or the cost of maintaining a home’s value. This is not a measure of actual expenditures; Statscan doesn’t ask homeowners whether they put a new deck in their backyard.

But to calculate depreciation, Statscan does use something real: prices for new homes. And over the pandemic, those prices surged, not only because of strong demand, but the rising price of lumber and other building materials.

So far, homeowners’ replacement costs have risen by 13 per cent over the past year. Still, it’s an aspect of shelter CPI that could be primed for a slowdown as the broader housing market tumbles, easing the pressure on inflation in that area.

Interest rates and inflation are closely linked, which is why the Bank of Canada has been pushing up its key rate to try and keep inflation to a target of 2%. But it’s a careful balance between controlling inflation and not tipping the economy into a recession. Note - since this video was published in June, inflation has risen to 8.1% in July.

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