Photo: James Bombales

Canada’s annual pace of inflation shot up in February, surprising economists who had expected it to stay significantly lower. The cause of the boost? According to one economist, the housing market had a role to play.

The Bank of Canada’s ideal rate of inflation is at or below 2 per cent. While in January the rate sat at 1.7 per cent, it jumped to 2.2 per cent in February.

“Overall, core inflation hit 2 per cent earlier than our modelling suggested,” writes Scotiabank VP of capital markets economics Derek Holt, in a recent note.

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One factor that could be pushing the rate higher? Falling activity in the Canadian housing market, which has seen sales and prices drop over the past two months.

“There are the uncertain drivers stemming from housing market developments [to consider],” writes Holt. “New home price gains peaked in the middle of last year as the pace of gains rose from about 1 per cent year-over-year in mid-2015 to almost 4 per cent last year before pulling back to 3.2 per cent year-over-year in January of this year.”

Holt writes that if home prices continue to fall, it could affect other related industries, and contribute to the rising rate of inflation.

“If prior increases to house prices are easing then expect this to carry some effects on related categories with lags (homeowners’ insurance premiums, slow adjustments to property taxes and spillovers into other price categories like already falling furniture prices, etc.)”

Of course, if inflation continues to move upwards, that could trigger the Bank of Canada to hike the overnight rate, which would in turn raise mortgage rates and likely further cool the housing market.

As RBC senior economist Nathan Janzen wrote in a recent note, the overnight rate — which currently sits at 1.25 per cent after a January hike — is still 175 basis points below what the Bank of Canada considers the “mid-point” of its long-run neutral level.

“We expect the [Bank] to remain cautious about the pace of interest rate hikes in light of trade uncertainty and the increased sensitivity of [household debt],” he writes. “We, nonetheless, still expect rates to grind gradually higher this year and next.”

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