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What Is Sticky Inflation? How is It Hurting Homebuying?

What Is Sticky Inflation? How is It Hurting Homebuying?

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    Sticky inflation refers to situations where prices do not adjust as quickly to supply and demand changes, which can lead to persistent inflation. Unlike other forms of inflation that can be easily corrected through adjustments in interest rates or monetary supply, sticky inflation presents challenges for central banks and policymakers. 

    When inflation becomes sticky, its economic effects can be more prolonged, difficult to control, and tame without causing a recession. Sticky inflation can typically last for years rather than months. In this article, we will explore the concept of sticky inflation and its impact on the housing market and discuss its implications for the Canadian economy.

    Key Highlights

    • Sticky inflation is a type of inflation that remains persistently high or stuck above the inflationary target.
    • The BoC sets and adjusts its monetary policy to achieve its inflation target by closely monitoring economic data and adjusting interest rates. 
    • Sticky inflation presents challenges for the BoC, which must carefully balance raising interest rates to control inflation without causing a recession.

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    What is Sticky Inflation?

    Sticky inflation is when consumer prices and wages do not respond immediately or fully to changes in supply and demand in the economy. In Canada, sticky core inflation is the primary concern for the Bank of Canada (BoC). Core inflation is a reading of the Consumer Price Index (CPI) excluding volatile food and energy prices. The risk is that core inflation will become stuck above the 2% target as demand continues to outstrip supply in the economy. 

    The challenge the BoC currently faces is that raising rates too fast can cause the economy to fall into a recession. Not raising interest rates enough will allow prices to continue to increase and remain elevated, leading to persistent sticky inflation. Higher interest rates will be required to restore stability if high inflation sticks. 

    How does sticky inflation affect the Canadian housing market?

    Sticky inflation impacts monetary policy as it becomes difficult to control inflation. As inflation remains high, the BoC carries out monetary policy measures by increasing interest rates. Increasing mortgage rates add to the affordability crisis as interest rates are increased in an effort to control inflation and borrowing costs rise. This makes mortgages more expensive and decreases purchasing power for buyers. 

    The limited housing supply only makes the crisis worse. With a shortage of homes on the market, the demand for housing outweighs supply leading to bidding wars and further driving up house prices. 

    The impact of inflation also affects the ability of households to qualify for mortgages. With rising costs and higher interest rates, lenders become more cautious. This can make it more difficult for individuals to meet mortgage qualification requirements and purchase a home.

    Causes of Sticky Inflation

    There are several causes of sticky inflation in Canada, from the housing market’s status to how tight the labour market is in Canada– though not all are included in the core inflation data that the BoC uses to make interest rate decisions. The main driver of sticky core inflation is the imbalance between supply and demand in the economy. 

    Housing Market

    The housing market has so far not reacted as the BoC expected when they started to increase interest rates. This strength in the housing market is currently attributed to new constructions and real estate listings lagging compared to demand and adding to price pressures. With such a tight housing market, strong population growth due to immigration is further fuelling the housing market shortage. 

    As the housing market sees persistent shortages and affordability issues, this impacts the rental market driving demand and, with it, rental prices. As fewer people are able to enter the housing market, and immigration remains strong, the demand for rentals is increasing, outpacing rental supply and driving up prices to unaffordable levels. 

    Job Market and Wage Growth

    Canada’s labour market remains tight due to strong population growth from immigration and strong economic activity. This adds to both the supply and demand in the economy as newcomers are helping to ease worker shortages. 

    The strength of the labour market and the low unemployment rate is contributing to further wage growth, which could signal that the economy is still overheated, fuelling inflation. Recently, wages have finally outpaced inflation, which is good news for workers dealing with the high cost of living; however, it’s bad news for the BoC as wage growth needs to subside and unemployment needs to rise to control inflation. 

    Consumer Spending and Acceptance of Inflation by the Public 

    As interest rates increase, the BoC expected that consumer spending would slow in response; however, the economy still appears to have excess built-up demand. This can be attributed to excess demand during the pandemic, where discretionary spending items like travel and dining in restaurants were off-limits. Another factor contributing to high consumer spending is that during the pandemic, many households were able to build savings that they are now dipping into for discretionary spending as the economy fully re-opened. 

    To compound this is the expectation that inflation is expected to remain high. As the population accepts that inflation is here to stay or that prices may continue to increase further, they are likely to adjust their spending habits by spending their money now rather than later as they believe their purchasing power will decrease as time goes on. This shift can lead to increased consumption and economic growth as they buy now to avoid paying more in the future. 

    Dynamics in the Housing Market & Inflation Combined

    The dynamics in the housing market, combined with inflation, play a role in shaping the overall economic landscape. While inflation impacts consumer behaviour and purchasing power, it also affects housing and rental prices, as many potential homebuyers get pushed out of the market. These can have far-reaching economic consequences, including possible risks of speculative bubbles and market instability. 

    Excess Demand in the Housing Market

    Excess demand in the housing market means more potential buyers are searching for homes than the available supply. This imbalance between supply and demand can lead to increasing prices and decreasing purchasing power.  

    One of the main reasons for excess demand in the housing market is the shortage of homes for sale. With fewer properties on the market, potential buyers are forced to compete with one another, driving up prices. This increased competition among buyers contributes to a sustained level of high prices, as sellers can take advantage of the strong demand by maintaining elevated listing prices.

    Population growth due to the rise in immigration is currently adding to this significant demand for housing. Additionally, real estate investors and homeowners looking to build wealth through property investment who have the money to afford increasing prices and interest rates add to this demand.

    Impact of Inflation on Shelter Costs

    Rising inflation rates directly affect shelter prices. Building materials, labour, and other construction costs rise as inflation increases. These higher costs are passed on to potential homebuyers and renters by increasing their shelter costs.

    Surging mortgage rates, driven by rate hikes to fight against inflation, make borrowing costs more expensive, leading to unaffordability for many. In addition, low inventories and bidding wars in the housing market fuel excess demand, driving up prices further. 

    As potential homebuyers get priced out of the market, excess demand spills into the rental market, increasing competition and prices. As mortgages come up for renewal, landlords will pass these increased costs on to renters through increases in rent. 

    Stock Markets Affecting the Canadian Economy

    Fluctuations in stock prices directly impact consumer spending, investor confidence, and borrowing costs, affecting the overall economic landscape. When stock prices are performing well, investor confidence tends to increase. This can lead to higher levels of consumer spending as individuals feel more financially secure and are willing to make larger purchases. On the other hand, when stock prices decline, investor confidence may diminish, causing consumers to tighten their belts and reduce their spending. 

    Stock market fluctuations can also affect borrowing costs. When stock prices are high, interest rates tend to rise due to increased investor demand for bonds, resulting in higher borrowing costs. This can make it more expensive for individuals to obtain mortgages, potentially cooling the housing market. Conversely, during periods of stock market turmoil, interest rates may decrease as investors seek safer assets such as bonds, making borrowing more affordable and stimulating the housing market. In the current market, we’re seeing both, which is creating more fluctuations and volatility in the stock, money, and housing markets.

    The Fight Against Sticky Inflation

    Sticky inflation can have significant economic implications, including its impact on the housing market. The BoC closely monitors inflation through CPI and core CPI. Increases to interest rates are used as an intervention tool which aims to control price pressures, maintain economic stability, and support sustainable growth. 

    The challenge now rests in balancing increases, as raising them too sharply can lead to a recession. However, not increasing them enough will allow inflation to remain sticky or continue to rise.

    Bank of Canada’s Role in Controlling Inflation Rates

    The Bank of Canada sets and implements monetary policy to maintain price stability and promote economic growth. One of the main tools the Bank of Canada uses to control inflation is adjusting interest rates. By raising interest rates, the BoC aims to reduce excess economic demand. Lowering interest rates encourages borrowing and spending, stimulating economic activity and potentially increasing inflation.

    Additionally, the Bank of Canada closely monitors various economic indicators, such as consumer prices and unemployment rates, to assess the level of inflationary pressures in the economy. Based on this data, the central bank formulates and adjusts its monetary policy to achieve its inflation target. The Bank of Canada’s ability, and the public’s expectation of its ability,  to bring inflation under control is crucial for maintaining economic stability.

    Statistics Canada’s Data on Sticky Inflation & Housing Market Trends

    According to recent data from Statistics Canada, sticky inflation has had a significant impact on the housing market in the country. Inflation rates have risen, translating into higher housing market prices.

    The latest report from Statistics Canada shows that inflation was up 2.8% in June, largely due to a drop in gasoline prices, while elevated grocery costs and mortgage interest costs contributed the most to the increase. These price pressures have led to increased shelter costs, including rent and homeownership expenses.

    As inflation persists, it erodes the purchasing power of consumers and puts pressure on housing affordability. This challenges policymakers to navigate the dynamics of sustained price growth while maintaining economic stability.

    Frequently Asked Questions

    Welcome to our Frequently-Asked Questions (FAQ) section, where we answer the most popular questions designed and crafted by our in-house mortgage experts to help you make informed mortgage financing decisions.

    What is sticky inflation?

    Sticky inflation is when inflation remains stuck due to prices lagging in response to supply and demand.

    How is sticky inflation in 2023 affecting Canada’s housing market?

    Sticky inflation is affecting the housing market as the BoC will need to continue to increase interest rates to bring down inflation if inflation remains stuck above the 2% target. This will lead to higher mortgage rates, increased unaffordability and lower purchasing power.

    When will sticky inflation go down in Canada?

    Sticky inflation is harder to control and has the potential to persist for years. The BoC must find a balancing act that can continue to lower inflation without causing a recession.

    Final Thoughts

    The Bank of Canada is committed to managing and achieving its inflation target in order to balance the economy. As inflation remains sticky, it must carefully monitor and adjust its approach to interest rate increases to avoid pushing the economy into a recession. 

    As the housing market continues to feel the effects of high inflation and interest rate increases, affordability remains the largest challenge for potential homebuyers. Avoid being trapped by the effects of sticky inflation, reach out to nesto’s mortgage experts today.

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