One economist says the Bank of Canada should change the way it looks at inflation, highlighting the central bank's current inflationary issues are more of a housing problem.

James Orlando, director and senior economist at TD Economics, said in a report Tuesday that more than half of Canada’s total inflation comes from shelter inflation and has become the “single biggest factor” standing in the way of the central bank achieving its two per cent inflation target. 

“Mortgage interest costs are rising at the fastest pace ever, while rents have soared alongside low vacancies,” Orlando said in the report. 

“This has shelter inflation running at 6.2 per cent year-on-year. Given its huge 30 per cent weighting within the CPI (consumer price index) basket, this component alone has accounted for more than half of overall Canadian inflation.”

In an interview with BNN Bloomberg Wednesday, Orlando said rental costs in Canada are “structural in nature.” He said the country has experienced “huge population growth” amid low housing supply leading to record low vacancy rates spurring increased rent inflation due to supply and demand imbalances. 

“If the Bank of Canada cuts rates, are we going to fix that supply-demand imbalance? I don't think so. There's a lot of factors at play, structural factors, that are going to keep shelter inflation high in Canada for much longer than the Bank of Canada is probably comfortable with,” he said.

On Tuesday, Statistics Canada reported that Canada’s annual inflation rate slowed to 2.9 per cent, lower than an annual rate of 3.4 per cent a month earlier. 

Tu Nguyen, an economist with accounting and consultancy firm RSM Canada, said in a statement Tuesday that excluding shelter, inflation is “down to 1.5 per cent,” adding that monetary policy “has basically done its job.”

Given the outsized impact of shelter prices on Canada’s inflation data, Orlando said the central bank should “start looking past the influence of shelter inflation, as it has under past regimes.” 

“For as long as the BoC (Bank of Canada) continues to focus on inflation metrics which are being held up by shelter inflation, Canadians will suffer under the weight of high-interest rates,” he said. 

Based on recent communications from the Bank of Canada, Orlando said it is clear the central bank is not ready to look and the inflationary picture without the impact of shelter inflation.

He also highlighted that regardless of how fast the Bank of Canada decides to lower interest rates, shelter inflation will continue to have an outsized impact. Orlando’s report looked at how fast the central bank could affect shelter inflation based on the timing of potential rate cuts.

The report found that the Bank of Canada would have “little ability to cool shelter prices.”

“In other words, a good measure of inflation is one that moves with the economy and doesn’t have a single sector skewing the index. The BoC’s three core measures were supposed to do this,” Orlando said in the report. 

He added that as the economy has “flatlined since last spring,” core metrics used by the central bank are “less connected with the economic cycle” because of the structural factors in Canada’s housing market. 

“And the fact that one sector is driving this disconnect means that the current inflation metrics aren’t doing a good enough job at guiding monetary policy for the broad economy,” Orlando said. 

Communication challenge 

The persistence of shelter inflation presents the Bank of Canada with a communication challenge, according to Orlando, who added that shelter inflation will likely be elevated in Canada throughout the year. 

“If the Bank of Canada is laser-focused on that component of inflation and how that's impacting the rest of inflation, do they cut interest rates?” he said adding that inflation is under control if the central bank looks past the impact of rising shelter costs. 

According to Orlando, based on the central bank's previous preferred inflation metric, inflation is “as close to target as we can get” and economic growth has been flat under the pressure of higher interest rates. 

He also highlighted all factors except for shelter costs are “well-behaved for inflation.” 

“I think if the Bank of Canada can speak to that and say that ‘we're looking at the direction of inflation over the next year and we're seeing that we think things are working. We think that things have moved in a way that we believe that future inflation will come down.’” 

“That will open the door for them to say: ‘We recognize that shelter inflation is high. It probably will remain high for the foreseeable future, but we believe that the direction is right and we are able to cut interest rates.’”