why inflation is lower than it appears

Per the latest release of Consumer Price Index (CPI) data from Statistics Canada on September 17th, Canada’s annual rate of inflation ticked down to (just below) 2% in August. This is good news for consumers and the Bank of Canada alike, with there being broad-based declines across the CPI. The one major outlier in inflation today is shelter (rising at 5.3% annually), which comprises almost 30% of the basket of goods and services in the CPI.

Clearly, shelter is propping up the CPI inflation calculation, with inflation excluding shelter sitting at only 0.5%. Within the shelter category, there are two specific elements that are elevated: mortgage interest cost (rising at 18.8% year-over-year) and rent (+8.9%). The mortgage interest portion is fairly self explanatory: Canadians are spending more on mortgage interest because interest rates have gone up. And since the majority of Canadians choose fixed-rate mortgages, renewers are still facing higher rates today than those they locked in five years ago, even as rates have started to fall. This shouldn’t be a concern to the Bank of Canada, as this will decrease in time as rates come down further.

The rental piece, however, is a bit more complicated. The rental market in Canada is fragmented, and comprehensive rental data is notoriously hard to come by. Once a year we get average rental rates from CMHC (in January, pegged to the previous October), but for the rest of the year we’re left with a variety of sources, mostly tracking the asking rental rates of vacant units. Looking at the rennie intelligence advertised rental database, average asking rents in three of Canada’s major markets have all declined over the past year by between 5% (in Toronto and Calgary) to 8% (here in Vancouver). While these data points tell us something about rental trends in Canada, it's useful to consult other data  sources to cross-check the findings.

With this in mind, we also looked at rentals.ca, the listings platform that regularly reports on rental rates in 35 Canadian municipalities across seven provinces. This data source, too, shows decreasing rental rates in Vancouver, Calgary, and Toronto, however, it also shows increasing rents in other cities including Edmonton and Quebec City. Crucially, the average year-over-year change in rents, per the rental.ca platform, is just 2% for both 1-bed and 2-bed homes, a far cry from the 9% increase in the CPI.

According to CMHC, only 12% of rental units were turned over last year (where one tenant vacated and another moved in and paid market rent). Beyond these, the CPI rent index also considers existing tenants renewing their leases, and tenants in the middle of their lease terms. The largest Canadian provinces all have rent controls, meaning landlords are limited in how much they can raise rents annually. In British Columbia the current limit is 3.5%, while Ontario is 2.5%, and Quebec has a “suggested” limit of 4% (with some additional possibilities where tenants can refuse the increase), while Alberta does not have rent control. This suggests that the overwhelming majority of existing tenants, outside of Alberta, are facing rent increases in the range of 0-4%—again well below 9%.

Given market rents for new tenants are rising by, on average, 2%, and rents for existing tenants by a range of 0-4%, even if rents for existing tenants were rising rapidly in Alberta, it only accounts for 12% of Canada’s population. This would not be enough to push the average increase up to 9%. The difference likely lies in the methodology Statistics Canada uses to calculate its rent index. The national statistical agency uses its Labour Force Survey to collect rental information, which is a monthly survey of 56,000 households. Of that, approximately 12,500 households are renters, and of those, typically 8,000 homes are used in the CPI rent calculations. With an annual turnover rate of 12%, that would mean around 80 of those households per month would be new tenants paying market rents while the balance would be existing tenants. This small sample likely leads to the rent index underestimating rent increases when they’re rising quickly, and overestimating rent increases when market rents start to fall, as they appear to be now.

Let’s get back to the CPI: if we look at all items in the basket, excluding rent, inflation sits at only 1.5%. Given the discrepancy between the rent index in the CPI and average market rental rates, it’s likely that the true inflation rate for August is actually materially less than 2%—and falling.