Canada Inflation

Uptick in Inflation Could Push Back the
Timing of Additional Interest Rate Cuts

Inflation defies consensus with slight uptick. Inflation jumped to 2.9 per cent in May, up from a 2.7 per cent reading in April and above the consensus estimate of 2.6 per cent. This rise in headline inflation was largely due to higher prices for services, which rose 4.6 per cent in May. The Bank of Canada’s preferred measures of core inflation, CPI-median and CPI-trim, also reaccelerated to 2.8 per cent and 2.9 per cent, respectively. This equated to a 0.3 per cent month-over-month gain in core inflation, above the 0.1 per cent measure seen over the first three months of the year. With the Bank of Canada recently lowering its overnight rate for the first time in over four years, this jump in inflation is an unfavourable outcome and could slow the pace in which additional cuts materialize. Nevertheless, inflation remains in the BoC’s target range and further reductions in the policy rate are expected, supporting commercial real estate space demand and investment over the course of 2025.  

Investors scale back bets on future rate cuts. Money market probabilities for a further rate cut in July dropped from 65 per cent just prior to the inflation reading to roughly 50 per cent immediately following the release. Nevertheless, a July rate cut remains a real possibility, with interest rate swap markets continuing to price in an additional 50 basis points of easing by the end of this year. This is largely due to the fact that inflation expectations are beginning to normalize, Canada’s labour market is continuing to loosen — as job creation cannot keep pace with population growth — and a wave of mortgage renewals expected over the coming year are likely to put further downward pressure on consumption.

Commercial Real Estate Outlook

Housing continues to be a main driver in annual price growth. Shelter costs rose 6.4 per cent and were among the largest contributors to headline inflation in May. While mortgage interest costs eased, the annual pace of growth was still elevated, at 23.3 per cent, given the rapid rise in borrowing costs over the past two years. This has caused widespread homeownership hurdles across the country. Canada’s housing affordability index — the ratio between housing-related expenses and disposable income — hit historic highs in 2023. Due to this, many potential buyers have been redirected to the purpose-built rental market. Combined with historic population growth of 3.2 per cent annually as of the start of the second quarter, the national multifamily vacancy rate is sitting at an all-time low of sub-2.0 per cent. As a result, rental inflation continues to be a main driver in price appreciation, hitting 8.9 per cent in May. With strong demand dynamics, along with more favourable financing provided by the CMHC, multifamily holds as a preferred investment option.

Hotels showing strong underlying performance. Service inflation reaccelerated in May, partially fueled by a 16 per cent annual increase in the cost of hotels. This reinforces the ongoing recovery within the hotel property sector. Combined with limited supply growth — with some major metros across Canada witnessing a decrease in total inventory — hotel performance metrics are showing healthy gains. As of the end of the first quarter, occupancy has largely returned to 2019 levels, supporting annual average daily rate and revenue per available room growth of 8.0 per cent and 9.6 per cent, respectively.      

* Through February; ** Through 1Q 2024

Sources: Marcus & Millichap Research Services; Altus Data Solutions; Bank of Canada;
Canada Mortgage and Housing Corporation; Capital Economics; CoStar Group, Inc.; Statistics Canada