Reflation Acceleration

June inflation south of the border was hotter than British Columbia in June — a stunning 4.5% jump in the core CPI measure.

That’s the highest in three decades, even though one-third of the price increases were due to car prices.

This chart below shows what’s happening, and it’s giving borrowers and those on fixed incomes the heebie-jeebies.

For inflation to be a real threat to mortgage rates, however, it must be persistent. For that to happen, inflation expectations need to break away from the central bank’s 2% target, supply chain disruptions and labour shortages need to continue, and/or people need to spend, spend, spend, including spending the record savings they’ve accumulated over the past 15 months.

That persistence is looking more likely, assuming you believe our trusty economist friends. A Wall Street Journal poll last week showed economists boosting their inflation forecasts across the board, to average 2.58% from 2021 through 2023, a level last seen in 1993, it says. That was a year when Canada’s key lending rate averaged four points higher than today — although it’s unlikely we’ll see the same degree of monetary tightening in today’s overleveraged economy.

Central bankers have maintained that the acceleration in inflation is temporary, and it mostly is. But numbers like today’s could make them nervous enough to pull forward their timetables for the first rate hike.

As it stands, the market is shrugging it all off, as you can see from the collapse in the 5-year forward rate spread (which is a market estimate of how much higher the 5-year bond yield will be five years from now). This indicator is a very rough gauge of how much 5-year fixed mortgage rates might increase by 2026. As you can see, it’s not enough to panic over…yet.

Investors want to see proof that future inflation is a boogeyman worth fearing, and it may take multiple ominous inflation prints—like we saw today—to convince them. Or, it may take the Fed and/or BoC to hint that they are getting worried. We’ll bet more on the latter happening first.