The Bank of Canada (BoC) recently held its key overnight rate at 5.0%, forecasting weak growth but leaving the door open for more rate hikes to control inflation, which could stay above the target for another two years. The BoC’s primary monetary policy tool is its policy interest rate, which it adjusts to stimulate or cool the economy.
Today, I will discuss this dilemma that the BOC is currently facing and how their actions affect us all, either directly or indirectly. It is challenging to be in the position of the decision-maker, knowing that every choice they make can have an impact. Let us delve deeper into this topic to gain a better understanding of it.
Increasing interest rates can have both pros and cons. On the positive side, higher interest rates can curb inflation and stimulate savings growth. For instance, when people are discouraged from borrowing and encouraged to save, they typically spend less money, which can slow inflation. Moreover, when interest rates trend upward, it can be good news for savers as financial institutions usually respond by raising interest rates on high-interest savings accounts (HISAs).
Conversely, higher interest rates can weigh on economic activity. For instance, higher borrowing costs can slow spending. Moreover, if interest rates rise too quickly, it could lead to a slowdown in growth or even a recession.
The decision to increase or not increase interest rates depends on various factors. For instance, strong economic growth tends to lead to higher interest rates, while weak growth leads to low interest rates. The BoC also considers factors such as inflation, the state of the job market, and the housing market.
Whether the BoC should increase interest rates depends on carefully analyzing the current economic climate and the potential impact of such a decision on the economy.
It’s time to peek into the Canadian economy, and I’m here to give you the scoop! According to recent economic data, the Canadian economy is going through a rough patch, like a stormy sea that’s having trouble finding its calm. The GDP report for the second quarter of 2023 showed a sharp slowdown in economic development, with output contracting by 0.2% at an annualized rate. It’s like the economy hit a speed bump while cruising down the highway.
Despite all this, there is a silver lining, as recent CPI data indicate that inflationary pressures remain broad-based, with CPI inflation averaging close to 3%, in line with the Bank of Canada’s projection. However, with the recent increase in gasoline prices, CPI inflation is expected to be higher in the near term before easing again. Inflation is playing a peek-a-boo game, showing up when we least expect it.
The Bank of Canada has been raising interest rates to combat inflation. But just like a chef adding salt to a dish, too much can make it hard for businesses and consumers to borrow money. Though this may be challenging, reducing the amount of money available for spending and investment can help combat inflation. However, not only consumers and businesses are affected by this, but also the government.
When interest rates rise, Canada’s national debt is significantly affected, and the consequences can be severe. According to the Department of Finance, a one percentage point increase in interest rates in the first year alone can result in a staggering $3.8 billion increase in debt charges. This puts a strain on government finances, which can lead to limitations on available funds for social programs and infrastructure.
Higher interest rates also make it more expensive for the government to borrow new money and refinance outstanding debt. Government of Canada bond yields are now at their highest level since 2007, making it significantly more costly for the government to borrow new money and refinance outstanding debt. This can lead to a decrease in investor demand for government bonds, further escalating borrowing costs.
Moreover, higher interest rates can exacerbate budget deficits as governments must borrow more money to pay interest on their debt. This can result in further downgrades in the debt rating for Canadian governments and an increased risk premium attached to our debt.
Interest rates can have a significant impact on the real estate market, particularly on the purchase price of properties. A property buyer’s borrowing power and affordability are directly influenced by interest rates. When interest rates are low, buyers can borrow more money, which increases demand and drives up property prices. Conversely, high-interest rates reduce borrowing power, decrease demand and lead to lower prices.
Low interest rates can bring more buyers into the market, increasing property competition. This competition can drive up prices, making it harder for buyers to find affordable properties. On the other hand, high-interest rates can decrease competition, leading to more affordable prices.
Interest rates in Canada have had quite a journey over the years. At one point, they reached a record high of 16% in February 1991 while hitting an all-time low of 0.25% in April 2009. Throughout the years, interest rates have gone up and down, with some memorable moments. Every time the economy changes, the BOC steps in with their monetary policy to stabilize the market.
The supply has reached all-time highs with 4.21 months of housing inventory in the GTA region as buyers wait on the sidelines.
In my previous issue, I quoted James Laird of Ratehub.ca, who believed that the Bank of Canada would hold interest rates instead of increasing them for the 11th time. This is because, in chasing the inflation target, the Bank of Canada risks destabilizing the market.
If you’re renewing your mortgage in the next 18 months, strap in and get ready for some higher interest rates. But don’t worry, you’re not alone – about 3.4 million Canadians are in the same boat. According to a recent poll, nearly three-quarters of those renewing their mortgages feel jittery. But don’t let the butterflies in your stomach get the best of you. Switching lenders requires you to do a little stress test, and many people might struggle to get through if the rates are increased further.
Given the supply and demand situation, it would not be ideal for the BOC to focus on inflation as their metric in isolation.
In conclusion, the Bank of Canada’s decision to increase or decrease interest rates is a balancing act that can significantly affect our economy and daily lives. While higher interest rates can help control inflation, they can also weigh on economic activity, making borrowing more expensive and potentially leading to a recession. As we have seen, the decision to increase interest rates also affects the government’s finances, the real estate market, and the purchasing power of consumers and businesses. As we face economic uncertainty, we must monitor the Bank of Canada’s decisions and their potential impact on our financial well-being.