“The sensible thing is to take the heat now and avoid more heat later,” said Giovanni Gallipoli of UBC.
The Bank of Canada has been caught in a balancing act to cause a recession and keep the economy afloat, according to a BC economist.
Last week, Bank of Canada Governor Typh McLem reiterated that the bank may need to raise its key interest rate by 3% to bring inflation back to target. He said the bank may need to “move faster, it may need to take a bigger step” to avoid rising inflation.
“They say that if we need to cause a recession by raising interest rates, we are ready to pay that price,” said Giovanni Gallipoli of the University of British Columbia. “It will be painful.”
As the price of goods and services rises, raising interest rates is a means of cooling demand and putting less pressure on prices, Gallipoli said.
Inflation becomes dangerous when people’s expectations of it are “fixed”, triggering a “vicious circle” of price increases, and wages cannot be maintained, he said.
“If you don’t do it now [increase interest rates]you risk things overheating and then expectations build in and it becomes much harder for the monetary authorities to keep prices under control, ”Gallipoli said.
“The sensible thing is to take the heat now and avoid more heat later.”
Inflation was caused by the printing of more money during the COVID-19 pandemic. It has advanced due to supply chain disruptions, trade restrictions, especially with China, and the Russian invasion of Ukraine, disrupting the production and supply of basic products such as oil and wheat.
The Bank of Canada sets what is called the overnight interest rate, now at 1.5%, compared to 0.25% in December 2021. The key interest rates are the higher interest rates that banks charge on loans. Currently, the base interest rate is 3.7%.
Low interest rates overstimulated the economy with more borrowed money in the system, leading to rising asset prices.
“If your mortgage has a fixed interest rate of 2%, as many people have, with inflation of 7%, the bank is actually paying these people 5% in real terms to borrow money. This is very stimulating, “Gallipoli explained.
How high will the interest rates be?
Gallipoli says there is no solid answer, as monetary policy cannot immediately affect key inflation conditions, such as war, disrupted supply chains and energy prices.
But he said he expects Bank of Canada interest rates to be at least 3% by December.
Ontario-based mortgage broker Ron Butler says it will increase five-year mortgage terms to or above 5.25% as banks benefit from overnight interest rate increases, as well as additional risk as housing prices fall as people they can take less loans for their purchase.
“I do not see [the Bank of Canada overnight rate] as nickel less than 3%, “Butler said of the tightening cycle.
Butler says the immediate pain will be felt with equity credit lines, which have reached a record low of 2.95% from mid-2020 to early 2022. Now interest rates are likely to exceed 5% by the end of the year and payments will immediately reflect this.
His advice to prospective buyers is to “enjoy the summer” and “look” until Labor Day. Even then, it may be advisable to wait until the New Year, he said.
He says key interest rates could rise even higher in 2023, although anything above 7% would cause an “unmanageable problem”.
The rate of increase will also be managed by the Bank of Canada, he said.
The problems will start if or once again people lose their jobs, according to Butler.
“The history of this country is that when Canadians have jobs, they will drink rainwater and eat weed to pay mortgage payments. I want to say that this is a very important thing for Canadians. But you are more concerned about unemployment, because with unemployment there is no return than if you lose your job – how to make the payment on your mortgage?
How will housing prices be affected?
Thomas Columbia, a professor of housing economics at the University of British Columbia, says house prices will fall in this environment, but affordability is unlikely to improve.
For example, for a home purchased for $ 500,000 with a 5% down payment at 2.5% interest, the payment would be $ 2,212. If the new rate is 5%, the monthly payment increases to $ 2,873. The value of such a home will have to be reduced by 20% (up to $ 400,000) in order for a new home buyer to pay approximately the same at a higher rate ($ 2,268).
“So, the house is falling a little, but the accessibility is still probably worse. And you will probably have more people who want to hire, so rents are likely to escalate, “he said.
Davidoff said landlords with existing tenants who have protection against rent increases under British Columbia law will feel the pinch as repair costs and mortgage payments increase.
“So, shed a tear for the master,” he said.
As most times, there are different factors for house prices, Davidoff said. Although interest rates could lower prices, counteracting this will increase construction costs and builders abandon projects, creating supply shortages, and immigration continues to rise all the time, he said.
gwood@glaciermedia.ca
With a file from Canadian Press
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