It might be time to reassess that budget—the Bank of Canada has once again hiked interest rates.
Last Wednesday, the country’s central bank raised its policy interest rate by 75 basis points to 3.25 per cent, the highest it’s been since 2008. Canada’s biggest banks, including TD and RBC, followed suit, raising their prime lending rates by the same amount.
By raising interest rates, the Bank of Canada is impacting the amount of money Canadians are able to borrow in the form of mortgages and lines of credit, as well as increasing the amount of interest customers have to pay on loans.
This is the fifth rate hike in approximately six months. The Bank of Canada continues to increase interest rates in an attempt to tackle runaway inflation. Earlier this summer, the inflation rate hit a 39-year high of 8.1 per cent. Thanks to a drop in gasoline prices, inflation has since eased to 7.6 per cent. But the bank says this isn’t a reason to relax.
“That has helped bring the pressure down on inflation,” said Carolyn Rogers, the Bank of Canada’s senior deputy governor, during a press conference. “Apart from that, though inflation has broadened and increased. Certainly the raises have helped, but commodities in general remain volatile, so there’s still a chance that we get pressure back up in the other direction.”
The war in Ukraine and COVID lockdowns in China continue to impact the supply chain, preventing manufacturers and suppliers from meeting demand. Rogers explained that demand in Canada remains strong, but to reach the bank’s goal of two per cent inflation, it needs to continue curbing demand through interest rate hikes until it balances with supply.
“We have seen some early signs that monetary policy is working. Interest-rate sensitive parts of the economy—the housing market being an obvious example—have seen some pull back,” Rogers said.
The one scenario that the bank is concerned about is if Canadians start to make long-term decisions based on the idea that a high rate of inflation is here to stay. “That’s the entrenchment that we talk about that would be damaging to the economy,” Rogers said. “If that starts to occur, it makes inflation much harder to get down. It means monetary policy has to do more and rates have to go higher to get inflation down.”
How long will the rate hikes last?
When asked whether interest rates are expected to keep increasing, Rogers was cagey with her response. “We’ll take the next decision when it comes,” she said. The bank is expected to reassess its rates on October 26.
In a report published around the end of August, CIBC theorized that the 3.25 per cent rate should remain throughout 2023 with no additional hikes. However, CIBC recanted this theory in a later report, saying: “We’ll be lifting our target for the end of this tightening cycle, with another 25-50 [basis points] on tap for October. Even in October, the Bank is likely to want to leave the door open for a further move until it gets more definitive evidence of a deceleration in growth and inflationary pressures. We see that as likely to be in evidence over the next two quarters.”
Rogers mirrored this statement during a speech last Thursday, saying it will take time to get inflation down and there could be bumps along the way.
What does this mean for mortgages?
Many mortgage holders across Canada are feeling the effects of increased interest rates. A mortgage is one of the most common types of debt held by Canadians. According to the Canadian Financial Capability Survey, in 2019, 40 per cent of Canadians had a mortgage, with the median amount of those mortgages being $200,000.
For those with a fixed-rate mortgage, the interest hike won’t affect them until they have to renew. CIBC estimates that approximately one-fifth of mortgage holders have to renew their fixed-rate contract in a given year.
As for mortgage holders with a variable rate, 70 per cent have fixed payments, meaning the payments don’t change, only the amortization period does. The other 30 per cent are feeling the immediate impacts of the rate hikes.
There is concern with the fixed-payment, variable-rate mortgages that the latest interest hike has caused many of them to reach their “trigger rate”. This means the interest rate has gone up so much that an individual’s monthly payments are only covering the interest and are not paying down any of the principal loan. If interest rates pass this trigger, monthly payments will go up. Those most affected will be individuals who took out loans in early 2020 when interest rates were at 0.25 per cent.
During a conference call discussing its third quarter earnings, RBC revealed that 80,000 of its customers are about to surpass their trigger rates, causing an average increase of about $200 per month. An individual’s monthly payment increase will depend on the size of the loan, the amortization period, and what the rate was when the customer borrowed the money.
Canadians may also have more difficulty qualifying for mortgages. Anyone making a down payment of less than 20 per cent on a property must pass Canada’s mortgage stress test. The test shows lenders that a borrower can make mortgage payments at either the rate offered by their lender or the Bank of Canada’s five-year fixed rate, whichever’s greater. As interest rates go up, so does the five-year fixed rate. It now sits at 4.33 per cent.
How do you prepare for interest rate hikes?
For those concerned about paying off their mortgage amidst interest rate hikes, the Canadian government suggests paying down as much of your debt as possible before an interest-rate increase. “If you have less debt, you may be able to pay it off more quickly. This will help you avoid financial stress caused by bigger loan payments,” the government said.
Other suggestions include cutting expenses so you have more money to pay down your debts, paying the debts with the highest interest rates first so that you’re spending less money on interest, consolidating debts with high interest rates into a lower interest-rate loan, and making sure you have an emergency fund to deal with unplanned costs.
As Rogers said during her press conference, the most important factor is to not let the idea of high inflation sway your long-term spending decisions, as this can negatively impact the Canadian economy
“The thing that the governing council is most focused on is getting inflation back to target,” she said.