The Bank of Canada’s (BOC) decision to raise interest rates by a quarter basis point again last week came as a surprise to many and solidified the reality that the Bank has taken an aggressively hawkish position on the cost of money. The BOC had already reversed a historically unprecedented 7-year policy of record low interest rates on July 12th by topping the rate up to 0.75%. The second-rate rise in less than 2 months sent the value of Canadian dollar up but also had a direct impact on increasing mortgage costs and making business and commercial lending more onerous on borrowers as well.
Canada’s big five banks immediately responded to the hike by announcing that their own respective mortgage rates would increase as well. The increase will have a powerful impact on the national housing market. In some regions where recent changes already had a significant cooling effect, the increase will only further make borrowing costs higher, particularly for first time buyers trying to enter the market. The move will also dissuade better prepared buyers who already have equity in the market from buying more or better-quality housing as equity growth and buying demand cools due to loss of market dynamism.
30% of Canadian homeowners who have variable rate mortgages will now have to adjust their household spending to make ends meet. While the rate rises may seem insignificant, the pace of the rate increases means that incrementally more expensive borrowing costs will accumulate and add up. This month’s increase also suggests that the Bank will likely increase rates again in October, as this matches the now emerging pattern of accelerating rates and lines up with the BOC’s increasingly hawkish and tightening rhetoric, and market expectations.
Many are scratching their heads as to why the BOC is raising rates so quickly. Inflation is very low at 1.2%. The BOC is known and respected throughout the world as one of the most successful inflation targeting Central Banks. This reputation was earned in the late 80s and early 90s as the Bank increased and maintained very high interest rates to break the back of double digit inflation caused by the 80s stock market and credit growth booms. The effect of these rapid rate rises on real estate, borrowing costs for consumers and businesses and consumer spending will be adverse. Tembo has several ideas.
First, the national economy is experiencing a big growth spurt and GDP growth rates increased by 4.5% in the second quarter. This was largely due to strong consumer spending, made affordable by a stable and healthy job market, some modest wage gains, and cheap borrowing costs. By raising rates, the BOC expects growth to cool to more sustainable medium to long term levels while sending signals to consumers to spend and borrow more Conservatively. There is also a broader international push by Central Banks to end the era of dirt cheap money, and the BOC, in the trendsetting style its admired for, is charging ahead.