The Bank of Canada’s aggressive one percent interest rate hike on Wednesday surprised many and is likely to have a significant financial impact on many Canadians, an economist says.
“It’s going to have an immediate, pretty dramatic effect on a lot of people’s borrowing costs,” Stephen Brown, senior economist for Canada at Capital Economics, told CTV’s Your Morning on Thursday.
“The bank tells us it will do whatever it takes to bring inflation back down.”
Most economists had already expected a serious move of 75 basis points. The jump to 2.5% from 1.5%, however, is the central bank’s biggest single increase since 1998 and the fourth increase this year. Yet the bank made it clear that it was not done.
Earlier surveys showed economists had expected a 50 basis point increase in September. Brown forecasts a 75 basis point hike, followed by another quarter of a percent in October, for a total of another percentage point increase before the Bank of Canada holds.
Brown added that the Bank of Canada’s “whatever it takes” warning includes the risk of a downturn in the economy.
There are already fears that rising interest rates could push the country into recession, but most economists said the bank had few other options to quickly tame rising inflation.
The annual rate of inflation rose to 7.7 percent in Canada in May, the highest level since 1983 and well above the Bank of Canada’s two percent target. While the central bank forecasts inflation to peak at 8% in the coming months, Capital Economics forecasts a peak of 8.3%.
Last week, the Royal Bank of Canada predicted that the country was headed for a moderate and short-lived recession.
Still, there were “encouraging signs” globally of easing inflation, Brown said, with some commodity prices starting to cool and global shipping prices falling sharply.
“We should see some commodity prices start to come down in the coming months,” he said.
NEW HOME OWNERS
One sector that sees a significant impact from rate hikes is the housing market. Median home prices have already fallen sharply since April, and the Canada Housing and Mortgage Corporation expects the market to fall 3.5 percent overall, with some forecasters predicting a steeper drop of up to 20 percent.
Capital Economics is among forecasters predicting a 20 percent drop.
“[It’s] partly a reflection of how incredible the earnings have been over the last year,” Brown said.
Home price inflation is currently running around 25 to 30 percent, depending on the measure you look at, Brown said, so a 20 percent forecast only wipes out a year’s worth of gains.
Holders of variable rate mortgages will take the biggest hit, but Brown does not expect the bank to raise rates above 3.5 percent.
“I just think that given the rise in mortgage rates that we’re seeing, additional pressure on interest rates, it’s very likely that we’re going to see more declines in home prices,” Brown said.
“The bank is unlikely to go further than that much, just because of the fairly significant downside risk in the housing market at this stage.”
MORTGAGE PAYMENTS ARE GOING UP
New homeowner Youssef Shehata knew interest rates would rise when he looked to buy a home, but he was still surprised by the Bank of Canada’s aggressive move this week. He has seen his mortgage payments increase by about $300 a month since he bought his Toronto condo in March, he said.
“When I bought my condo downtown, I did the math and built a buffer because I knew it might go up a little bit, but I never expected it to be this much,” he told CTV News Channel on Thursday. He added that it was frustrating to see his mortgage payments rise month after month.
Shehata said it was too late to consider reselling because he could not guarantee he would be able to sell the apartment for the price he paid. On the other hand, he says his friends have seen their rent increase dramatically as well.
“Now that interest rates are going up, it’s very hard for people to buy, it’s hard for me to sell. So I think I’m in a very difficult situation … even if I didn’t buy in the first place – the rental market is crazy anyway.”
Another curveball in his budget plans was the spike in his living expenses like groceries. He is cutting back on some of his discretionary spending, eating out less and has also asked his cleaner to stop coming. It was a tough decision, Shehata said, knowing she too had to deal with the rising cost of living.
“Inflation has been … crazy for the last few months and now I have to redo all the calculations and redo the math,” he said.
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