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BMO Sees Immigration to Canada Boosting Inflation in Short Term

Canada’s strong immigration-driven population growth is boosting consumption and housing costs, making inflation stickier — at least in the short term.

While the Bank of Canada sees high levels of immigration as having an overall neutral effect on the economy as newcomers add to both demand and supply, an analysis by Bank of Montreal Chief Economist Doug Porter found there’s a modest correlation between a higher rate of inflation and strong population growth.

The evidence suggests that the role of population growth in driving up demand for housing and consumption may outweigh its contribution to reducing wage pressures. For Canada, the rapid growth buoys spending and jobs markets at the same time the central bank is trying to cool the economy. It also worsens existing housing shortages, putting a floor under price declines and leading to a quick rebound in key housing markets.

“The extra spending and the extra demand for housing is almost instantaneous, whereas it might take a new worker a little bit of time to really act as a dampener on inflation,” Porter said in an interview. “The short-term impact does tend to lift inflation a little bit, whereas longer term, it turns to more of a neutral.”

Canada has been setting fresh records in population growth in recent quarters as Prime Minister Justin Trudeau’s government raises its immigration targets. In the first three months of this year, the population expanded by 0.7%, the highest rate of growth in any first quarter in data going back to 1972, with immigration responsible for 98% of the gains.

The nation recently surpassed 40 million people and growth is expected to continue at a rapid pace. Trudeau’s government views high immigration as a way to broaden the labor market as global competition for skilled workers intensifies.

But increased consumption and a turnaround in the housing market are making the Bank of Canada’s job in taming inflation harder. Strong population growth helped fuel unexpectedly high household spending earlier this year, prompting the bank to resume rate hikes in June after a five-month pause.

Statistics Canada is set to release inflation data for June on Tuesday, with the headline annual rate expected to fall to 3% from 3.4% in May, according to the median estimate in a Bloomberg survey. The Bank of Canada has pushed back its expected date for reaching the 2% target by six months to mid-2025.

Population growth is also pushing up demand and costs for housing, leading to a higher inflation rate. Roughly every 1% rise in population translates to a 3% increase in real home prices across the 18 countries analyzed over the past two decades, according to Porter.

Soaring housing costs and rents are captured in shelter inflation, which has the biggest weight in Canada’s consumer price basket. Shelter rose 4.7% in May from a year ago and rents jumped 5.7%.

Asked last week whether increased immigration is inflationary, Bank of Canada Governor Tiff Macklem said it’s “probably roughly neutral,” but that it’s “hard to know exactly what the net effect is.”

“If you start with an economy with excess demand and you add both demand and supply, you’re still in excess demand,” Macklem said after boosting borrowing costs for a second straight meeting, bringing the benchmark overnight rate to 5%. “What we’re seeing is the excess demand in the economy is more persistent than we thought.”

The bank’s latest projections see inflation lingering around 3% for the next year before gradually declining to 2% in about two years. The economy is now expected to avoid a contraction, with growth numbers revised upward.

“The fact that the bank raised rates again suggested that they put a significant emphasis on demand coming from immigration,” Rishi Mishra, an analyst at Futures First Canada Inc., said in an interview. “Increased demand for inelastic goods like housing blunts monetary policy transmission by keeping house prices and rents elevated for longer. Rapid population growth is also part of the reason why inflation is expected to stay elevated longer and why growth outlook is stronger.”

The combination of higher real gross domestic product growth and inflation as a result of more robust population growth will also mean higher interest rates, Porter argued.

“Even if it’s roughly neutral for inflation, it’s going to be positive for nominal GDP growth, which really drives interest rates,” he said. “Higher population growth does go hand in hand with somewhat higher interest rates, baseline interest rates over time.”

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