2.5% inflation means Bank of Canada’s interest rate hikes should end

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Ted Rechtshaffen: 2.5% inflation excluding mortgage costs means it’s time for the central bank to stop raising interest rates

Published on June 28, 2023 • Last updated 7 hours ago • 3 minutes reading time

The Bank of Canada building in Ottawa. The Bank of Canada building in Ottawa. Photo by Sean Kilpatrick/The Canadian Press Files

The Consumer Price Index (CPI) rose 3.4 percent year-on-year in May, a significant drop from April’s 4.4 percent year-on-year reading, but that tells nothing of the real story.

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Not surprisingly, there is a component of CPI that still shows significant inflation. The mortgage interest cost index rose a whopping 29.9 percent year-on-year. You wouldn’t be alone if you looked at that number and thought, “What the hell are they expecting?” Shockingly, as surely as one plus one equals two, mortgage costs for a majority of Canadians go up when the Bank of Canada hikes interest rates .

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When it comes to mortgage interest costs, a Bank of Canada rate hike is like suggesting someone with high blood sugar eat a sugar cube to lower their blood sugar levels.

The Bank of Canada’s logic in raising interest rates is to contain inflation and bring it back to 2 percent. Interestingly, their goal has been between one and three percent for the longest. Of course, we can see that a meaningful component of CPI is diametrically opposed to a focus on raising interest rates and lowering inflation. Given this anomaly in mortgage interest costs, it certainly makes sense to look at CPI without this component.

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Excluding the mortgage interest cost index, the May CPI is 2.5 percent yoy, very close to the target inflation rate. I repeat, the CPI excluding mortgage rates is 2.5 percent. A year ago, that overall CPI rate was 7.7 percent. It has fallen by 5.2 percentage points within a year. Whether it’s central bank rate hikes or simply normalizing inflation, it’s a significant change by any measure after the global economy’s rollercoaster ride caused by COVID-19.

I’m always told that raising interest rates is meant to help curb inflation, but it takes time as the effects are delayed. If the CPI is now at 2.5 percent and the sizable rate hikes are having a lagged effect, doesn’t that suggest we’re done using rate hikes to contain inflation? After all, the Bank of Canada just made another rate hike in early June. With inflation already at 2.5 percent, how many lagged effects are we facing?

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I know it’s not that easy. You can slice inflation in a number of ways, and if you focus on expected salary increases or food prices, it can be argued that higher interest rates are needed to kill the inflation monster.

I just don’t buy it.

All of these factors are included in the 2.5 percent CPI figure. The only item removed is what you know will rise if the Bank of Canada continues to hike interest rates.

Many economists expect the Bank of Canada to hike rates by another quarter point in July. “Unless there are major negative surprises from these (upcoming) data releases, we continue to expect the bank to hike the overnight rate by a further 25 basis points in July before stepping back on the sidelines for the rest of this year,” Royal said said Claire Fan, economist at the Bank of Canada.

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The Bank of Canada partially justified its June interest rate hike by citing a slight rise in CPI in April to 4.4% from 4.3%.

At 2.5 percent today (excluding mortgage interest costs) and with the central bank already raising interest rates by 4.5 percentage points in just 17 months from January 2022, enough is enough. The Bank of Canada has not seen a rate hike this large since the late 1980s. From February 1987 to June 1990, the key interest rate rose by 5.5 percentage points. Alarmingly, the key interest rate then fell by 9.25 percentage points over the next three and a half years.

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Higher interest rates have already had a major impact on inflation and will continue to do so for some time. It’s time for the Bank of Canada to stop raising interest rates.

Ted Rechtshaffen, MBA, CFP, CIM, is President, Portfolio Manager and Financial Planner at TriDelta Financial, a boutique wealth management firm focused on investment advice and financial planning for high net worth individuals. You can contact him directly at [email protected].

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