The Bank of Canada has raised its benchmark interest rate by the largest amount in more than 20 years, sharply increasing the cost of borrowing in a bid to curb runaway inflation.
Canada’s central bank raised interest rates by a full percentage point to 2.5 percent on Wednesday. This is the bank’s largest one-off rate hike since 1998.
The bank’s interest rate affects the interest rate Canadians get from their lenders on things like mortgages and lines of credit. Two of Canada’s major banks have already hiked interest rates in response, with Royal Bank and TD raising rates to 4.7 percent from 3.7 percent Thursday morning.
The other major lenders are expected to follow shortly.
All other things being equal, a central bank lowers lending rates when it wants to stimulate the economy by encouraging people to borrow and invest. It raises interest rates when it wants to cool down an overheated economy.
After cutting its interest rate to a record low early in the pandemic, the bank has now hiked its rate four times since March as part of an aggressive campaign to fight inflation, which has risen to its highest level in 40 years.
Economists had expected the bank to raise its interest rate by three-quarters of a percentage point, but the full percentage-point hike exceeded even those high expectations. And even after this record-breaking rise, further hikes are expected as the specter of stubbornly high inflation is so serious.
Bank of Canada Governor Tiff Macklem said the bank made the decision to frontload its rate-hiking campaign because Canadians are “more concerned that high inflation is here to stay. We cannot allow that.”
“We are raising our policy rate quickly to prevent high inflation from taking hold. If that’s the case, it’s going to be more painful for the economy — and for Canadians — to bring inflation back down,” he said, noting that the bank doesn’t expect the official rate of inflation to rise until June will fall to three percent next year and only return to the two percent target in 2024.
Big migration justified, says economist
Laval University economist Stephen Gordon says it is clear the bank miscalculated the speed at which inflation would heat up and is now trying to correct course on the fly.
“They’re playing a little catch-up here and that’s partly why they’re rising so quickly,” he said in an interview.
Although the size of the increase was outside of the norm, he said it was justified given the unprecedented challenges facing the economy today.
“We’re in a situation where we have supply chain disruptions, really high oil prices and demand backlog due to the pandemic,” he said.
“We’re in uncharted territory here, so there’s very little that can lead us down the path of the story. We just have to feel the way forward.”
The housing market will feel the pinch
The impact of higher interest rates will be felt most immediately in the housing market, as adjustable rate mortgages are closely tied to the central bank’s policy rate.
Canada’s housing market has been scorching hot for most of the pandemic as record-low interest rates boosted demand and pushed prices to all-time highs. But that direction reversed in the first half of this year, as the central bank’s signal that higher rates were on the way took the wind out of insatiable demand.
Average prices have fallen across the country since March, the Canadian Real Estate Association says. Wednesday’s rate hike will not reverse this trend.
Potential homebuyers must stress-test their finances to ensure they can withstand higher borrowing rates, and Wednesday’s rate hike will raise that test to about 7 percent for fixed-rate loans and 6 percent for variable-rate loans.
If borrowers fail the stress test, lenders are required to lower the amount they lend them until they meet the bar.
Anyone who currently has an adjustable rate loan — and anyone looking to buy one — will likely find their mortgage rates increasing almost immediately.
With a $400,000 mortgage amortized over the normal 25-year timeframe, a borrower taking out a loan at a 3 percent interest rate pays $1,893 a month. But if their interest rate goes up a full percentage point, as the bank’s rate just did, that monthly payment jumps to $2,104 a month. That’s an extra $211 a month from their budget.
If the rate increases to five percent, the monthly payment increases to $2,326, which would be more than 22 percent more than what was originally paid.
- Has your rent gone up lately? We’d love to hear what challenges you’re facing — as well as tips on how to overcome those challenges. Email firstname.lastname@example.org.
Further rate hikes expected
Such increases were exactly what homeowner Tim Capes feared last month when he switched his home loan from an adjustable rate to a fixed rate mortgage.
“We felt the pain every time interest rates went up and we got a letter from the bank that our mortgage was going to go up a certain amount and the budget was going to be a little bit tighter,” he told CBC News in an interview.
After seeing his payment grow each time the Fed raised its interest rate in March, April, and June, Capes decided to bite the bullet and set a fixed rate that costs him about $700 more per payment than before. but at least with the certainty that nothing will change in the next five years.
“I definitely wish I had done it sooner, when the rates were even lower, because picking a variable was a mistake in the first place,” said the Markham, Ontario resident. “But we ultimately decided it was a mistake that we could afford to correct. So we did it.”
Economists expect several more rate hikes, as do Capes.
“When those rate hikes start, it’s a lot easier to know that my mortgage won’t go up with every single rate hike.”