Understanding Inflation in Canada | CPI and Mortgage Rates

Q: How is inflation measured in Canada?

By the Consumer Price Index (CPI) published monthly by Statistics Canada. The CPI tracks the price of a basket of goods and services representative of Canadian household spending.

Q: Why the 2% target?

It is considered optimal: low enough to preserve purchasing power, high enough to avoid deflation. The agreement is renewed every five years between the Bank and the government.

Q: What is the link between inflation and mortgage rates?

High inflation pushes the Bank of Canada to raise the policy rate. This directly increases variable rates and indirectly raises fixed rates through inflation expectations in bond yields.

Q: What is core inflation?

It excludes the most volatile CPI items to reveal the underlying price trend. The Bank uses CPI-trim and CPI-median as its preferred measures.

RefinancePro.club

What Is Inflation?

Inflation refers to a generalized and sustained increase in the prices of goods and services in an economy. It reduces the purchasing power of money: with the same amount of money, you can buy fewer goods today than a year ago if inflation is positive. In Canada, the official measure is the Consumer Price Index (CPI) published monthly by Statistics Canada. The CPI compares the cost of a representative basket of goods and services purchased by Canadian households from one period to another. An inflation rate of 2% means that basket costs on average 2% more than a year ago. For mortgage borrowers, inflation is a critical factor because it directly determines Bank of Canada interest rate decisions.

The CPI and Its Components

The CPI measures price changes for a basket comprising eight major categories weighted by their importance in household spending: food (approximately 16%), shelter (approximately 30%), household operations, furnishings and equipment, clothing and footwear, transportation (approximately 16%), health and personal care, recreation, education, and reading. The shelter component is particularly relevant to the mortgage market as it includes mortgage interest cost, rent, property taxes, and maintenance costs. Paradoxically, when the Bank of Canada raises rates to fight inflation, the 'mortgage interest cost' component of CPI increases in the short term, creating a temporary effect of higher measured inflation.

The 2% Target and the Inflation-Control Framework

The control range runs from 1% to 3%, with a 2% target. This target is considered optimal: low enough to preserve Canadians' purchasing power but high enough to avoid deflation, a generalized price decline that can trigger a vicious cycle of deferred purchases and economic slowdown. The agreement between the Bank and fédéral government is renewed every five years. In the December 2021 renewal, the Bank kept the 2% target while committing to consider maximum sustainable employment in its decisions. When inflation sits within the 1% to 3% range, the Bank considers monetary policy to be working adequately. Above 3%, restrictive measures (rate hikes) are generally necessary.

The 2021-2023 Inflationary Episode

The recent inflationary episode perfectly illustrates inflation's impact on mortgage rates. In 2020-2021, COVID-19-related supply chain disruptions, combined with massive fiscal stimulus measures and exceptionally low interest rates, triggered a price surge. Annual CPI rose from 1.0% in January 2021 to a peak of 8.1% in June 2022, the highest level since 1983. Facing this situation, the Bank of Canada undertook the fastest and most pronounced hiking cycle in over 40 years, raising the policy rate from 0.25% to 5.00% between March 2022 and July 2023. For Quebec borrowers, this increase was brutal: monthly payments on variable-rate mortgages rose dramatically, and new buyers' borrowing capacity dropped by approximately 25%.

Impact on the Mortgage Market

High inflation: the Bank raises the policy rate, variable rates increase immediately, fixed rates rise through inflation expectations in bond yields, and borrowing capacity decreases significantly
On-target inflation (2%): rate stability, predictability for borrowers, favourable conditions for medium-term mortgage planning
Low or declining inflation: policy rate falling or stable, lower mortgage rates, but underlying economic risks (unemployment, slowdown) that may affect property values
Inflation expectations: influence fixed rates through long-term Government of Canada bond yields. If markets anticipate persistent inflation, fixed rates will rise even before the Bank acts
Shelter component of CPI: mortgage interest costs are part of CPI, creating a paradoxical short-term effect during rate hikes

Inflation Indicators to Monitor

Beyond headline CPI, the savvy mortgage broker should monitor several complementary indicators. CPI-trim and CPI-median, the Bank's preferred measures, give a more precise reading of the fundamental trend. Inflation expectations measured by Bank of Canada surveys of businesses and consumers influence bond yields and therefore fixed rates. Crude oil prices, housing costs, average hourly wages, and global supply chain disruptions are all factors that can push inflation off its anticipated path.

Strategic Advice for Quebec Brokers

Mortgage brokers must adapt their recommendations to the inflationary context. During high inflation, a fixed rate offers predictability and protection against further hikes. During disinflation (declining but above-target inflation), a variable rate may offer medium-term savings if the Bank cuts its policy rate. The key tool is monthly monitoring of Statistics Canada CPI releases (typically the third Tuesday of the month) and reading Bank of Canada commentary on this data. By combining this analysis with each client's personal situation (risk tolerance, holding horizon, income stability), the broker can formulate informed, personalized recommendations.