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Bank of Canada’s high interest rates worsening inflation: Benjamin Tal

Mortgage interest a key component of overall inflation rate, economist says

 CIBC Capital Markets managing director and deputy chief economist Benjamin Tal delivers his economic update at the Canadian Apartment Investment Conference in Toronto on Sept. 13. (Steve McLean, RENX)
CIBC Capital Markets managing director and deputy chief economist Benjamin Tal delivers his economic update at the Canadian Apartment Investment Conference in Toronto on Sept. 13. (Steve McLean, RENX)

The Bank of Canada should have stopped its overnight interest rate increases at 4.5 per cent instead of five per cent in its effort to fight inflation, CIBC Capital Markets managing director and deputy chief economist Benjamin Tal says.

“There is still a risk that it will move again and that will take the overshooting to 75 or maybe 100 basis points, which is sub-optimal by any stretch of the imagination,” Tal told attendees of the Canadian Apartment Investment Conference at the Metro Toronto Convention Centre on Sept. 13.

While many experts predicted a recession would be underway by now, that hasn’t happened because consumers had banked $165 billion in extra savings during the height of the COVID-19 pandemic. So they still had money to spend while interest rates began to rise rapidly last year. 

Those extra savings are now largely gone, according to Tal, and credit card debt is rising. 

People still with savings are investing in guaranteed investment certificates at interest rates of more than five per cent, creating a less liquid market as that money is no longer available to spend.

Bank of Canada wields a lot of power

“The consumer ran out of money and whatever money is left is adjacent, so the consumer cannot resist the Bank of Canada anymore,” Tal surmised. “That's why the Bank of Canada is the most powerful central bank in the universe.”

The debt level of Canadians went up substantially 15 years ago when the United States was enduring its financial crisis and they’re now more sensitive to the risk of interest rate hikes.

“The debt service ratio in Canada is much higher than in the U.S.,” Tal said. “That's why whenever the Bank of Canada raises interest rates, you feel it immediately relative to the U.S. and that's why the U.S. (overnight interest rate) has to be higher to stay in the same place.” 

Shelter inflation has risen

Canada has been reducing inflation more than other countries and numbers continue to trend downward due to a number of factors.

Oil and other commodity prices have stabilized, supply chains are better than before the pandemic and retail profit margins are decreasing, according to Tal.

“Eighty-five per cent of the inflation that we're seeing now is domestically driven and more sensitive to the policies of the Bank of Canada,” Tal said.

The shelter inflation rate in Canada is at about 30 per cent due to higher mortgage interest payments and rents. While mortgage principal payments aren’t reflected in the consumer price index (CPI), mortgage interest payments are.

“The Bank of Canada is raising interest rates to fight inflation. Inflation is rising due to the fact that interest payments are rising," Tal said. “It's like putting a humidifier and a dehumidifier in the same room and letting them go at each other.

"It doesn't make any sense.”

Tal said Canada's inflation rate has already fallen to the Bank of Canada’s target of two per cent – if interest rate payments are excluded.

Shelter inflation in the U.S. is all about rent as Tal said it accounts for 40 per cent of the core CPI south of the border and is rising by about seven per cent annually.

Rental supply in the U.S. has risen dramatically over the past two years, he added.

Service inflation has come down

Eighty per cent of service inflation is attributable to wages and Tal said the labour market has normalized.

The high number of vacancies in the job market are primarily in low-paying positions in service industries where wages have risen minimally because small business owners haven’t wanted to increase them with the threat of a recession hanging over them.

“We are bleeding vacancies and therefore wage pressures are not rising in any significant way,” Tal said. “People are not quitting their jobs anymore. 

“During COVID, and over the past year, people were quitting jobs like there’s no tomorrow because there was a premium. If you went to another place, you got better money. 

“Not anymore. The premium is back to normal and the quit rate is back to where it was before the pandemic. 

“This is a market that is normalizing and if the market is normalizing, labour does not have the bargaining power and therefore wages will not be rising in a very significant way the way they did over the past year.”

More mortgages will be coming due

Fifty-seven per cent of outstanding Canadian mortgages will be reset in 2025 and 2026, according to Tal. People paying close to zero per cent interest will be faced with paying seven per cent unless the Bank of Canada significantly cuts rates in the interim.

Tal believes the Bank of Canada’s first interest rate cut will take place late next spring or early next summer.

“The economy, and your business in particular, can do extremely well with a three per cent overnight rate as long as it's predictable and stable,” he said. “It's not about the level of interest rates, it's about the trajectory.”

The housing market is slowing, condominium pre-sales are declining and, for the first time, Tal said condominiums purchased for investment are experiencing negative cash flow. While this may be painful, he believes it’s a necessary and healthy adjustment.

Housing crisis is worsening

The Ontario government has said 150,000 new housing units must be built annually over the next 10 years to meet demand, but there’s never previously been more than 70,000 built in a year and the capacity to build 150,000 doesn’t exist.

Meanwhile, the Canada Mortgage and Housing Corporation (CMHC) suggests an additional 3.5 million housing units on top of what’s being built will be needed by 2030 to lower prices to its target level.

“We have fewer workers per unit and therefore it takes longer to build,” Tal said. He added that 300,000 people in the construction industry will retire over the next 10 years, the number of apprentices is dropping and only two per cent of Canadian immigrants have a construction-related background.

The housing crisis may be even worse than acknowledged as the population of Canada has been under-counted. The CMHC had forecast a decade ago the country’s population would be 38.7 million today, while it’s officially 40.2 million.

“We have a situation in which at any point in time CMHC is coming with a forecast of population growth and, based on this forecast, resources are allocated to municipalities and they give them quotas of family units to build: rent and normal,” said Tal.

More solutions are needed

The population is likely close to a million more than the official number, largely due to non-permanent residents and foreign students, according to Tal. He thinks a cap should be placed on foreign students entering Canada until adequate housing is in place.

Tal had advocated for the removal of the GST on the construction of purpose-built rental apartments and the federal government announced on Sept. 14 it will do that.

“We need an affordability solution and a big part of this affordability solution is a renter solution,” Tal said, “and you cannot have a renter solution without developers.

“If it doesn't make sense to build purpose-built rental, you don't have a solution. We have to provide incentives to developers to build it.”

Tal also believes Canada needs an equivalent to the American 1031 Exchange, which enables investors to defer taxes on capital gains from property disposal.

If the sale proceeds from an investment property are reinvested into another property that’s like-kind in nature, an investor could avoid paying taxes subject to the 1031 Exchange guidelines.

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