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The data shows that interest rate hikes are now increasing inflation, not decreasing it

David MacdonaldAfter nearly a year of interest rate hikes designed to fight inflation, rents in Canada are going up, and food costs remain stubbornly high. And while they might have helped in the summer of last year, interest rate hikes are now actually increasing inflation.

The Bank of Canada’s target is to bring inflation down to two percent, but its strategy to achieve this with higher interest rates is failing on two major counts: it does nothing to lower the cost of everyday necessities like groceries or gas, and it’s leading to higher inflation in housing-related prices.

The Bank of Canada has done research on which expenditures are impacted when interest rates rise. It concludes that some areas, like housing, are heavily impacted, but most areas, like groceries and gas prices, aren’t.

The areas impacted are those you need debt to buy, like a house, and when interest rates rise, you feel it in higher mortgage interest rates. But we don’t buy things like food and gas with a mortgage, so interest rate hikes have no effect. For instance, the bank study predicts that with the hikes we’ve experienced so far, we’d expect to see a 0.04 percent increase in grocery store spending since we don’t buy groceries with debt impacted by interest rates.

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From research to practice, here’s what’s happening to prices captured in the Consumer Price Index (CPI):

Higher interest rates have the biggest impact on four key costs: housing prices, real estate commissions, mortgage interest costs and rent. Higher interest rates push the first two down, decreasing inflation, but push the second two up, increasing inflation. The net impact is that inflation decreased between April and September 2022 but increased between September and December.

To date, the only impact of rising interest rates has been to decrease the price of homes and real estate commissions. But even within the housing sector, the high cost of rent and rising mortgage interest rate costs are now completely offsetting that impact.

Bottom line: Overall, the data shows that interest rate hikes are now increasing inflation, not decreasing it.

Interest rate hikes have an obvious impact on the mortgage interest that people pay, but what’s less understood is the devastating impact those hikes are having on rent.

In November 2022, after eight months of rate hikes, rent inflation in Canada hit its highest point in over 30 years. This spike in rental prices has been driven by landlords passing on higher mortgage costs to tenants and tenants staying in rentals longer since home buying is too expensive.

Overall, rent, home prices, mortgage interest costs and real estate commissions added 1.3 percentage points to inflation in September 2022 and 1.4 percentage points by December 2022. Higher interest rates decrease home prices and commissions but increase rent and mortgage interest costs.

We need to lower house prices and rent inflation in Canada without increasing mortgage costs. This can be done in a number of ways that do not involve interest rate hikes: for example, by tightening mortgage rules for real estate investors, by stopping sweetheart tax deals for REITs buying up apartments, and by beefing up provincial rent controls to keep rents from increasing rapidly.

Interest rate increases are putting chronic stress on many Canadian households and it’s not even working to decrease inflation. So why is the Bank of Canada persisting with a failing policy rather than reversing course?

David Macdonald is a senior economist with the Canadian Centre for Policy Alternatives.

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