Last week, the Bank of Canada raised the interest rate again, bringing it to a 22 year high.
This week, Statistics Canada announced that our inflation rate tumbled to 2.8% in June, bringing it to a 27-month low.
So does that mean inflation is now under control?
Did the Bank of Canada make a mistake with another rate hike?
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For the past 12 months, everyone has been talking about raising the interest rate to slow down inflation.
So we saw 10 rate hikes and the inflation rate is now at 2.8%.
We are not that far from the Bank of Canada’s 2% target.
Does that mean they need to keep raising the interest rate until we see inflation at 2%?
And when we get to 2%, does that really mean things would become more affordable?
I think we are starting to lose sight of the true meaning of the inflation rate.
Let me bring up a couple fundamental things about the inflation rate that we should remind ourselves about.
#1 It Is a Year-Over-Year Measurement
A 2.8% inflation rate in June is comparing prices in June 2023 to June 2022.
So things are generally 2.8% more expensive in June this year than June last year.
But if we compare the prices in June this year versus May, the month-over-month inflation rate was 0.1%.
So things didn’t really get any cheaper.
Let’s use a $100 meal in 2020 as an example.
With a 10% inflation rate, the same meal would cost $110 in 2021.
If inflation stays high up at 10%, the same meal would cost $121 in 2022.
Now inflation slows down to 3% in 2023, the meal would still be more expensive than last year.
It will now be $125.
You see, inflation is now under control, but the meal is already 25% more expensive than 3 years ago.
Sometimes it is natural for people to relate a lower inflation rate to cheaper prices.
It is important to remember that prices are still increasing with a lower inflation rate, the price increase is just not as steep as before.
#2 Things in the Inflation Equation are Volatile
The inflation calculation is based on a number of items with different weights to represent their importance.
Food is a main item with a 9.1% inflation rate in June.
Mortgage interest is another main item, with an inflation rate of 30.1% in June.
So in order to bring the overall inflation rate down to 2.8%, we need some big negatives in the equation.
There are 2 items with significant price drop.
First one, no surprise, gasoline prices were 21% down.
The second one is interesting.
Rogers closed its $26-billion purchase of Shaw in April.
As part of the campaign, they had a bunch of promotional offers, like lower prices for cell phone plans.
So prices for telecommunication services were down 14.7% in June compared to a year ago.
And they were included as part of the cost of living for inflation calculation.
A few months down the road, when the Rogers promotion rates are over, it may bring the inflation rate back up again.
You can see how the overall inflation number can be very misleading.
If we take gasoline out of the data, the 2.8% inflation rate in June would become 4%.
If we take food out, it would be 1.7%.
If we take mortgage costs out, it would be 2%.
When we are looking at highly skewed and volatile data like this, is it still meaningful to continue raising the interest rate and kill our economy, just to bring that inflation number down to 2%?
Wouldn’t it make more sense to focus on the individual items with high inflation rate and bring those down instead?
We know mortgage interest is a big item in the inflation equation.
You keep raising the interest rate, mortgage interest keeps going up, inflation keeps going up.
It is counter intuitive.
When mortgage interests increase the landlords’ costs, they have to increase the rent.
When potential home buyers fail to qualify for a mortgage, they have to rent instead.
Do you know what the rent inflation rate is for a 1 bedroom condo in the Greater Toronto Area in the second quarter of 2023?
11.6%.
The average rent for a 1 bedroom condo is now $2,532.
Everyone keeps talking about making housing more affordable, but if they keep raising the interest rate, is it really making things better?
Or worse?
And don’t forget about the crazy population growth we talked about last week.
Unless the government can magically increase our housing supply significantly, I really can’t see how housing prices can come down.
That’s exactly what Toronto’s new mayor Olivia Chow aims to do.
We are going to talk about how she plans to solve our housing problem in an upcoming episode, make sure you subscribe and hit the bell now so you won’t miss it.