‘Vicious feedback loop’: The Bank of Canada hiked rates to push inflation down — but it’s also driving inflation up

Mortgage costs that have risen drastically are contributing to sticky inflation creating a vicious feedback loop" that will be difficult to break, experts say.

The Consumer Price Index - a broad-based measure of inflation - was 4.4 per cent higher in April than it was a year earlier, according to data released by Statistics Canada Tuesday morning, with mortgage interest and rent as the biggest drivers. In March, inflation was at 4.3 per cent.

In April, as more Canadians renewed their mortgages at higher interest rates, mortgage interest costs shot up 28.5 per cent from a year ago. Rent also rose, by 6.3 per cent.

Without mortgage costs, headline inflation would be 3.6 per cent - much closer to the Bank of Canada's target of around 2 per cent.

Mortgage costs filter slowly into the CPI over time, so they will be in inflation for a while," said Robert Kavcic, senior economist at BMO. But I wouldn't confuse this with thinking that higher interest therefore causes inflation ... in this specific category, they do for a while. But that is outweighed by cooling the economy down more broadly."

Still, the Bank of Canada has a difficult problem on its hands. By raising prime rates the Bank has contributed to higher mortgage costs, which in turn, keeps inflation sticky, said mortgage broker Ron Butler.

Last March, the bank began an aggressive rate-hike campaign to drive inflation down, pushing its key overnight rate to 4.5 per cent from 0.25 per cent.

It's a vicious feedback loop," Butler said. If the Bank were to raise the prime rate by another 25 basis points it would drive up mortgage costs further and we'd be in the exact same situation we're in now."

The bond market has also quickly reacted to stubborn inflation numbers, jumping by 20 basis points on Tuesday, keeping fixed-rate mortgages high, said Butler.

Fixed-rate mortgages are tied to the bond market and typically rise and fall in tandem with interest rates.

Because the Bank of Canada might only start decreasing its prime rate next year, bond yields respond by going up," he said. That means those looking to renew their mortgage in the next 10 days will be doing so at much higher rates."

And the longer it takes for the Bank of Canada to push down its key policy rate, the longer people will be paying higher mortgages, he added.

Another factor contributing to sticky inflation is extending amortization periods - the length of time it takes to pay off a mortgage. When homeowners prolong their amortization, it keeps their monthly payments in check as interest rates rise, but it comes at the cost of paying interest for a longer period of time, said Vince Gaetano, founder and principal broker at OwlMortgage.ca.

Static mortgage payment clients extend their amortization and don't expand payments. It's driving inflation because they don't need to adjust their discretionary spending, which you would have to do if your mortgage payments were going up," he said.

Gaetano has seen some amortizations extend to 60 or more years, which is problematic for the Bank's goal of getting inflation down to it's two per cent target.

The Bank is trying to do its job of getting inflation down, so extending amortizations is counterintuitive for what the Bank is trying to do," he added.

But that doesn't mean the Bank of Canada will change its monetary policy any time soon.

In January, bank governor Tiff Macklem said it was pausing hikes, at least temporarily. Economists forecast the Bank will likely stick to this promise for the rest of 2023.

We'll have to wait another month or two to see where the inflation numbers are before the Bank maybe changes its mind," said Gaetano.

Phil Soper, CEO of Royal LePage, said inflation has been halved in a relatively short period of time (it peaked to 8.1 per cent last summer) and economic progress rarely happens in a straight line."

April's inflation numbers aren't enough to derail the Bank's policy direction," he said. We'd really need to see an unexpected economic event like a spike in oil prices or another war. It's much more challenging to tackle inflation that we're importing from other countries. As far as managing inflation within Canada, it's well in hand."

With files from Josh Rubin

Clarrie Feinstein is a Toronto-based business reporter for the Star. Reach Clarrie via email: clarriefeinstein@torstar.ca