The Bank of Canada has taken the lowest interest and mortgage rates in Canadian history and in a manner of months, sent them skyrocketing at the fastest pace on record. The Bank of Canada completely underestimated and dismissed the extent of the potential for inflationary growth over the short to medium term. Tembo repeatedly wrote about the potential for the bank putting the economy and the housing market at risk by waiting too long to respond to inflation which was building up in late 2021 and early 2022. We even warned that the Bank of Canada was potentially putting itself into a corner, and forcing it to rapidly raise rates to taper inflation. That’s exactly what happened. The reason Tembo wrote this was because we keep a close eye on inflationary history. There have been many central banks that have put themselves in positions where rates were kept too low for too long. In Australia in the late 1980s and early 1990s, the central bank waited too long to raise rates to cool a then booming economy. It was forced to frantically raise rates which created a severe recession and very high unemployment. Former Australian Prime Minister Paul Keating, in an interview with the Australian Broadcasting Corporation, said he and his staff were calling Australia’s Central Bank weekly to ask staff why they were holding off on raising rates. The fear was the then growing inflation rate in late 1988 and 1989. Similar outcomes have happened in the past in the U.S. and Canada.
Now, how is the frantic rate hiking by the Bank of Canada actually impacting ordinary working people? Tembo has created a graphic showing how much of a financial hit the BOC’s actions have had. In late October of last year, mortgage interest rates were in the low to mid 2% range. Based on a $800,000 mortgage, an amount not alien to many people given how high house prices were, a 2% mortgage would cost homeowners just over $3,400 a month. Let’s say that a couple of two professionals in their late 20s, making $80,000 each in Toronto, took advantage of low rates in October 2021 and just bought a $900,000 townhouse in Markham. Their combined take home pay would hover in and around $9,000 a month. After utilities, insurance, property taxes, and basic bills, their household spending would eat up a little over half of their budget. If that couple were to make the same move today, they would be paying $5,000 for the same mortgage amount. With inflation continuing to remain problematic and prices rising, household costs would be in a very uncomfortable position. While housing prices have fallen in many places, they have plateaued in other regions, and declined only slightly in some high value categories. And competition remains fierce as many people are in cash positions and want to take advantage of good deals. It’s a very tough market out there.
These higher rates mean that a million dollar mortgage will cost buyers just under $2,500 extra a month. Very few people will be able to stomach those price increases. Our housing market has been put in a position where monthly mortgage payment costs have increased by 44%, forcing people to come up with an extra $18,000 a year AFTER taxes just to maintain their financial budgets and mortgage payments. This is a recipe for pain. It also explains why predictions of a recession are increasing. Homeowners will have a lot less cash for spending, investing, and saving. The good news is that Canadians are prudent and smart with their money (generally). Fixed rate mortgages dominate big bank balance sheets, so the number of homeowners whose mortgages will need to be renewed and who will face higher rates is generally small. At the end of the day, rates were never going to stay ultra-low forever. But there’s a big difference in a graduated rate increase cycle, and one where the central bank hikes rates 6 times in 9 months. The big lesson in all of this is that central bankers are not infallible, that they’re human and make mistakes too, and that the job of dealing with and forecasting economic changes is very, very hard. Stay humble and crack the economic history books!