Will go up? Won’t go up? We will know this Wednesday morning if the Bank of Canada raises its key rate or leaves it unchanged, as many experts predict. But at this point, the real question is how long it will take before interest rates come back down.
As the months pass, the noose tightens around households, businesses and governments who see their interest bills balloon.
Homeowners who had a variable rate mortgage have already felt the full force of the increase. But if rates remain high for much longer, many homeowners who opted for a fixed-rate mortgage will also experience payment shock.
To give you an idea, take a household that took out a $350,000 mortgage five years ago. If he renews it today, his rate will rise from 3.5% to 5.84%, which will increase the monthly payments by 22%, or almost $380. That leaves a $4,500 hole in the annual budget.
The shock will be even greater in the coming years. Firstly because more mortgage loans will mature. But then because they come with an even lower rate: 2.39% on average for those which will be renewed in 2025 and 1.96% for those which will be renewed in 2026, according to the National Bank.
Then, the contrast will be even more pronounced – and painful – with the new rate. Especially if there is no rate cut for a year or two, as some experts predict.
This will be particularly hard for households who purchased at the height of the pandemic. In the midst of bidding wars, they paid more than expected for a house whose value had plummeted. This will leave them with little room to absorb higher mortgage payments… other than reducing discretionary consumer spending.
Already, we feel that retail sales are in decline. We see that households are having more difficulty repaying their credit cards and their car loans. It is no coincidence that insolvency cases in Canada have increased by 22% among consumers and 37% among businesses over the past 12 months.
This backlash risks leading the economy into recession. But this is the price to pay to curb inflation, which is an even greater evil.
However, it is difficult to believe that the Bank of Canada will be able to reduce inflation which remains too high on the services side, due to wage increases, without this translating into job losses which will restore bargaining power to the employers.
The Canadian economy will perhaps get through this thanks to the strength of the United States which will serve as its locomotive. There, households are less affected by rising interest rates, since mortgages are fixed over 30 years. And the increase in productivity (which is unfortunately lacking in Canada) makes it possible to stimulate growth, without whipping up inflation.
So can we cross our fingers that inflation comes back into line without derailing the economy? Some economists make this bet.
But in the long term, it may be difficult to keep inflation around the 2% target due to a range of structural factors.
The aging of the population will keep the labor market under pressure, and therefore wages and services too. Meanwhile, the energy transition will increase the costs of goods. Just like the deglobalization which has been taking shape since Russia’s invasion of Ukraine and which is pushing Western countries to repatriate the production of critical products, products which are more expensive to produce at home.
Faced with these inflationary pressures, central banks may need to keep interest rates high for longer.
They cannot give up and let inflation climb to 3% instead of 2%, for example. The difference may seem small, but it would cause a loss of confidence on the part of different financial players and a general fall in the value of assets. Such a change of course would amount to an admission of failure by central banks which would have serious consequences.
Instead of telling the Bank of Canada what to do, politicians like Ontario Premier Doug Ford should mind their own business. Everyone has their role.
If they want interest rates to fall, governments must stop adding fuel to the fire, as they have done in recent years. By multiplying checks to the population. By adding expenses to their budget. Or by increasing the number of employees in the public sector much faster than in the private sector.
While economic updates are expected within a few weeks, rigor is required.
The position of The Press
Interest rates are likely to remain high for a long time, regardless of the politicians who put pressure on the Bank of Canada. Instead, they should mind their own business and avoid adding fuel to the fire in their next budget statement.