Shelter costs will continue to be the main driver of Canadian inflation “for the foreseeable future,” according to a new economics report from Desjardins.

The report’s author pegged rising mortgage interest, driven higher by elevated interest rates, as the main culprit behind runaway shelter inflation that’s making it more expensive to own and rent a place to live in Canada.

“According to our analysis, higher-for-longer shelter inflation will be the dominant driver of headline Canadian inflation for the foreseeable future,” read the report published Thursday.

“The sustained high pace of shelter inflation is expected to be almost entirely driven by rising mortgage interest cost.”

The findings are consistent with recent comments from the Bank of Canada about the impact of shelter costs on the Consumer Price Index (CPI), Desjardins’ senior director of Canadian economics noted in the report. 

“One of the key takeaways from the Bank of Canada’s January 2024 Monetary Policy Report is that shelter inflation is likely to be the single most important driver of year-over-year price growth in the first half of 2024,” said Randall Bartlett.

Bartlett said the central bank didn’t provide a forecast for shelter inflation beyond June of 2025, but it acknowledged that rising shelter costs would put upward pressure on inflation “for some time.”

“Our analysis supports this view, as prices for both rented and owned accommodation are projected to continue growing above their pre‑COVID pace beyond the end of 2024,” he wrote.

Shelter costs driven up by interest rates

Bartlett said the elevated pace of shelter inflation is being driven mainly by the rising cost of mortgage interest, which has increased in tandem with the Bank of Canada’s key lending rate.

The central bank’s overnight interest rate is set at five per cent, where it’s been since July of 2023.

That’s the highest level since 2001, and it’s contributed to a record-setting increase in mortgage interest growth, the Desjardins report said.

“Having averaged over 30 per cent year-over-year in the second half of 2023, mortgage interest cost inflation set new records throughout the year,” Barlett wrote.

“This trend will persist in 2024, as mortgages continue to renew at higher interest rates.”

Desjardins’ analysis projected that shelter price growth’s contribution to the CPI will grow through the first quarter of 2024, then will “gradually diminish” in the following months.

The report said shelter costs will average out to a monthly contribution of 1.8 percentage points to the CPI through the end of the year, nearly four times the average level in the five years prior to the pandemic, Bartlett noted.

Other price pressures easing

With shelter costs at historic highs, growth in other price categories “must be lower than in the past” for the Bank of Canada to see enough slowing towards its inflation target of two per cent, Barlett noted.

The report said that slowing effects from high interest rates will continue to ripple through the economy, creating weakness in consumer demand and taking pressure off the non-shelter components of the CPI.

“Non‑shelter core inflation – total inflation excluding shelter, energy and food – must come in sustainably below its pre‑pandemic pace to offset higher-for-longer core shelter inflation,” Bartlett wrote.

“We think it will.”

Bartlett said that price growth in food and energy has eased recently, helping to pull down other inflation categories and further offsetting elevated shelter costs.

With these factors in mind, he expects inflation will be brought down close to the Bank of Canada’s two per cent target by the end of 2024.

Desjardins’ analysis anticipates the high-rate environment will cause the Canadian economy to dip into a recession in the first half of 2024, with weakness in the labour market to follow.

“These trends will further validate the effectiveness of the Bank of Canada’s tightening, something that was already apparent during the second half of 2023,” he said.

“This should allow the Bank to begin a gradual rate-cut cycle by this spring, well before headline inflation has touched down at the two per cent target.”