The Bank of Canada is expected to hike interest rates by half a percentage point on Wednesday, a move aimed at curbing inflation, which is at the highest level in decades.
Economists are almost unanimous that the bank will hike interest rates to 1.5 percent on Wednesday, the second such hike in a row and a crystal-clear signal that the pandemic-induced easy-money era is over.
While that’s bad news for anyone who owes money or wants to borrow, it’s not hard to see why the bank feels compelled to act.
The price of everything from groceries to gasoline to housing has skyrocketed during the pandemic as supply and demand imbalances caused by COVID-19 are coupled with record-breaking amounts of stimulus cash to stoke inflation.
Officially, Canada’s inflation rate is 6.8 percent, the highest level in 30 years. The cost of basic necessities, like putting food on the table and having a roof over your head, has risen even more, with food and shelter rising 9.7 and 7.4 percent respectively over the past year.
The current rate of inflation for commodities is two to three times higher than what the bank likes to see. While low interest rates aren’t the only factor driving inflation, the central bank is feeling the pressure to act quickly to cool things down.
Nathan Janzen, economist at RBC, believes Canada’s central bank is on course for a string of consecutive above-average rate hikes until its policy rate reaches around 3 percent. Canada’s benchmark interest rate has not reached this level since the 2008 financial crisis.
“The question that is emerging is whether interest rates need to rise above this neutral zone to bring inflation back under control,” Janzen said.
Impact on the housing market
It’s hard to overestimate the impact that interest rates, which are more than double their pre-pandemic levels, would have on the broader economy. The most obvious impact would be in the housing market.
After rising at a rapid pace for most of the pandemic, Canadian house prices have started to cool since the central bank made its first tiny rate hike in March. Sales have fallen sharply almost everywhere, and selling prices have also fallen, from an all-time high averaging $816,000 in February to $746,000 in April.
May’s numbers are expected to show the pace of the downside accelerating, and that’s before factoring in the impact of this week’s expected rate hike.
CLOCK | Here’s what a central bank rate hike could do for the housing market:
How the Bank of Canada rate hike could affect house prices
Sung Lee, a mortgage broker at rate comparison website Rates.ca, said some buyers are already getting cold feet. And many of those still willing to step in are finding they can afford less than they anticipated.
“We’ve seen a slight drop in mortgage inquiries after the Bank of Canada hiked rates for the first time, which seems consistent with the recent housing market slowdown,” Lee said in a recent comment.
Anyone looking to get a mortgage to buy a home needs to stress test their finances to see if they can handle higher interest rates. And even the relatively small rate hikes that have taken place so far have left many potential buyers short of the new, higher bar. You’re then forced to buy something more affordable — or hold back altogether.
Currently, most borrowers are having their finances tested as if mortgage rates were 5.25 percent; this is significantly higher than the level many Canadians would currently receive from a lender.
But as those real lending rates continue to rise, so does the stress test bar. As a result, some potential buyers are “either holding off or turning to alternative methods to increase the mortgage amount they can afford, such as credit unions or private lenders,” Lee said.
Analyst calls for ‘aggressive’ rate hikes
Canada is far from the only central bank trying to fight inflation with higher lending rates, but strategists at Dutch bank ING say the Bank of Canada has a tougher job than some because its economy is so heavily impacted by what what her neighbor to the south is doing.
“To achieve the same level of monetary tightening, the Bank of Canada tends to need to be more aggressive in raising interest rates,” James Knightley and Francesco Pesole wrote in a comment last week.
“We would argue that given the current macro environment, you cannot rule out the possibility of a 75-point raise.”
An increase of that magnitude would bring lending rates back to pre-pandemic levels – when central bankers around the world were cautiously trying to bring interest rates back to near-normal levels.
After more than two years of a pandemic, it’s unclear what “normal” means, but bank watchers agree the old rules are unlikely to apply.