Interest Rates Do Not Reflect Inflation

Steve Saretsky -
Happy Monday Morning!

We got a string of new data this past week confirming inflation in consumer goods, and housing are proving to be more than transitory. Canada’s consumer price index continued to drift higher with prices hitting an 18 year high, up 4.7% from last October. The recent floods in BC are already creating significant food and fuel shortages which is likely to compound on top of already high prices.

Meanwhile, national home prices jumped again, rising a whopping 2.7% month over month in October. This was the fastest price gain in seven months. This gain was led by Toronto where prices ripped 4.8% in one month. Keep in mind these price gains are tracked using a smoothed out hedonically adjusted index which strips out volatility from high-end home sales. In other words, this was a monster move higher that was not due to a change in the composition of homes selling. Policy makers should absolutely be concerned. On the whole, national home prices are now up 23% from last year.

To suggest policy makers have over stimulated the economy would be an understatement. The Bank of Canada should absolutely be reigning in stimulus measures but are trying to delay it as long as possible as they know higher interest rates will destabilize a highly levered Canadian economy (hint: housing). Bank of Canada deputy governor Lawrence Schembri was out this past week discussing future rate hikes, “There’s a lot of uncertainty about the timing of the closing of the output gap, so one should be careful not assuming it’s necessarily going to be the second quarter. It’s a range of six months that’s our best estimate”

What Schembri really meant but can’t say publicly is “We have a massive debt burden that will trigger a deflationary bust if we normalize interest rates, so what we’re trying to do is let inflation run hot while keeping interest rates suppressed for a prolonged period of time in order to lower the debt to GDP ratio. We’re doing our best to make sure interest rates do not reflect current inflationary conditions.”

Alas, the show must go on. Let’s watch.


1. Per Stats Canada, food inflation is just 3.8%. Where is Stats Canada eating? (Source: Acorn Macro)

Canada food inflation

2. Canadian home sales are well above normal and are on pace for their strongest year ever. (Source: The Globe & Mail)

3. Nearly every time Debt to GDP has spiked, real rates have turned sharply negative. (Source: Deutsche Bank)

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