Economists at TD Bank are predicting communications challenges ahead for the Bank of Canada if it cuts interest rates this spring while housing costs remain high.

The Bank of Canada is widely expected to start reducing its trendsetting interest rate this year after a series of rate hikes – with cuts coming potentially as early as this spring.

In a report published Wednesday, TD economists Beata Caranci and James Orlando said if rate cuts indeed come to pass this spring, it means rates will start coming down amid above-target inflation and high shelter costs.

This could lead to confusion among the public, the economists noted, and will “create a communication challenge” for the central bank when it comes to anchoring household inflation expectations, as people can be particularly sensitive to rising housing costs. 

“The Bank of Canada will need to convincingly pivot its public communication to emphasize that shelter costs do not define broader inflation trends in Canada,” the authors wrote.

“To neglect to do so runs the risk of leaving rates too high for too long and sacrificing too much economic growth.” 

WHAT IS HAPPENING WITH INFLATION?

The report noted that there is evidence that inflation is cooling across the consumer price index (CPI), despite high inflation for mortgages.

In November, the CPI rose 3.1 per cent on an annual basis, matching the previous month, according to Statistics Canada’s latest report. 

Mortgage interest costs were the most significant factor in the November CPI, rising 29.8 per cent year-over-year. Excluding those cost increases, the CPI would have been 2.2 per cent, just above the Bank of Canada’s inflation target of two per cent.

The share of products in “deflationary territory” is increasing compared to before the pandemic, the TD economists noted, and the number of products with inflation below three per cent has risen.

INFLATION EXPECTATIONS

If interest rate cuts drive demand – and higher prices – in the housing market, it may be more difficult for the Bank of Canada to “re-anchor consumer expectations,” the economists cautioned.

“There’s plenty of research to show that households anchor their inflation expectations within personal experiences and following home prices is practically a sport in Canada,” the report said. 

Households often “overweight inflation expectations” related items that have more extreme moves, such as housing, the authors explained.

“Household expectations may have been conditioned to be even more sensitive to upside shifts in prices than the decade prior to the pandemic in when inflation was a boring affair,” the authors said. 

With files from Bloomberg News