The Bank of Canada’s most recent rate hike on July 11, 2018, was telegraphed well in advance, with some economic arguments to support it, such as healthy employment and a rise in fuel prices. However, this was the 4th rate hike in the last calendar year, after no rate hikes at all for seven straight years, leading to serious questions about the timing of this increase, which brings the central bank’s key overnight rate to 1.5 per cent. Consumers with any sort of variable rate loan, such as a home equity line of credit, or a variable rate mortgage, will feel the pinch immediately. This is especially problematic for key housing markets in Vancouver and Toronto, which are just starting to recover from the decimation imposed by the OSFI stress test and compounded by rising interest rates over the course of the past year.
Central Bank’s Case for Rate Increase
One of the overtly stated objectives of the Bank of Canada is to regulate inflation, keeping it low, stable and predictable, with a target rate between 1 and 3 per cent:
The Bank of Canada aims to keep inflation at the 2 per cent midpoint of an inflation-control target range of 1 to 3 per cent. – Bank of Canada
The central bank’s primary tool for buffering inflation is its discretion to govern monetary policy by way of deciding on the key-overnight interest rate that the banks themselves must adhere to when borrowing from each other. This key interest rate also serves as a benchmark for banks and other financial institutions when they set rates for consumer loans, mortgages and other types of lending.
As such, the Bank of Canada is always on alert when inflation approaches the bank’s outside target limit, and especially the pace at which it is goes beyond the ideal 2 per cent midpoint. Statistics Canada reports that Canada’s annual inflation rate rose by 2.5 per cent in June, “as consumer prices grew at their fastest pace in more than six years,” – Global News. Higher energy prices, especially gasoline, coupled with more expensive airline tickets, meals out and an increase in mortgage interest payments are putting significant upward pressure on inflation across the country.
Bank of Canada Short-Sighted in July 2018 Rate Increase?
Obviously, our central bank has an important job to do in managing inflation, by way of monetary policy, but many experts contend that this latest rate increase was short-sighted and taken a bit out of context of what’s happening in the rest of the world, especially with the uncertainty south of the border.
The U.S. economy is currently posting some impressive growth numbers, with GDP growing 4.1 per cent in the second quarter of 2018, the highest since 2014, and with wages and salaries growing at their highest pace in nearly a decade. However, this growth is largely being fueled by tax cuts and federal spending, adding to the U.S. deficit, which raises questions of sustainability.
Additional uncertainty is being created by President Trump’s initiation of trade wars with China, Europe and even Canada. Our central bank factored in some of this uncertainty in its July rate increase decision, citing that the U.S. tariffs on steel and aluminum, and Canada’s retaliatory tariffs would only shave off about 0.7 per cent of Canada’s economic growth by 2020. The Bank of Canada steered clear of speculation regarding the possibility of additional tariffs in the auto sector, or the impact that extended U.S. trade wars will have on the U.S. economy and let’s not forget that NAFTA negotiations, at least for Canada, seemed to have ground to a halt.
Did the BoC Really Need to Raise Its Rate in July?
Amidst this uncertainty, did the Bank of Canada really need to raise its rate at this point? Household spending, which accounts for about $60 billion of our GDP, has already retracted this year, while the free fall of housing markets across the country, particularly in economic hubs like the GTA, are just now starting show signs of recovery from a huge decline earlier in 2018.
Outside of the U.S., which is enjoying a significant, but temporary, fiscal stimulus at a time of near full-employment, no other country in the developed world, other than Canada, has raised interest rates this year. The U.S. economy may have some wind in its sails now, but when the tax cuts and federal spending inevitably lose their stimulating effect, and the cumulative impact of Trump’s trade wars start to add up, inflation becomes a real concern in the U.S., justifying the Fed’s rate hikes this year.
According to David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates Inc., Canada is not nearly in the same situation as the U.S. Our temporary blip of inflation is being driven by gasoline prices, and minimum wage hikes. The uncertainty created by the U.S. administration’s trade wars should have been more than enough to give our central bank some pause to consider before raising rates for the fourth time in a year. Here’s Rosenberg’s take on the timing of the BoC rate hike in July:
Only time will tell if the BoC’s tightening move was a prescient one. But I come from the camp that says when uncertainty is running as high as it is, it’s best to sit on your hands and do nothing. Outside of the U.S., nobody else in the world is raising rates besides some emerging markets in defense of their sharply weakening currencies. While it is 100 per cent true that the Bank could always unwind the rate increase if need be, at the same time, it could have waited this one out to assess how the trade situation unfolds. – Financial Post
Impact of Rate Hikes on Canadian Consumers and Housing Market
Since July of 2017, the Bank of Canada has raised its key-overnight lending rate four times, for a total increase of 100 basis points. This collective increase will cost Canadian households an additional $10 billion to service the incremental debt, which is about equivalent to a one per cent pay cut. This is also happening at a time when home equity is dropping, and trade uncertainty is making many Canadians feel less secure about their jobs.
Canadians with various forms of unsecured or floating debt, with interest rates that change monthly such as variable-rate mortgages and certain lines of credit, will see the immediate impacts of the July rate increase on their upcoming monthly statements. This rate hike could also affect you if you need to renew or refinance your mortgage, or undergo a mortgage stress test on your mortgage application.
With the Bank of Canada signaling that more rate hikes may yet be warranted to keep inflation in check, mortgage applicants will need to be ever more vigilant to get a mortgage with terms that suit their needs, but still doesn’t leave them house poor.
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