The Bank of Canada issues an oversized rate

Borrowers across the country should expect their portfolios to take a hit after four rate hikes in five months

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With hot inflation like a “four-alarm fire” — as the Bank of Montreal’s chief economist, Douglas Porter, said so eloquently in a note to clients — the Bank of Canada is stepping up its efforts with a much more aggressive interest rate hike .

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Although the overnight rate is the central bank’s best tool for fighting inflation, it is generally used with finesse, in increments of 0.25%. But since this fire requires a lot more water, BoC Governor Tiff Macklem announced on July 13 that the bank would raise its target overnight interest rate by 1%.

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This brings the overnight rate to 2.50%.

An increase of this magnitude has not occurred since 1998. And while it will have immediate consequences for Canadian consumers, experts say it is a necessary step to extinguish the raging flames of inflation, even if it extinguishes the economy in the process.

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Macklem has trouble around every corner

Inflation hit 7.7% in May — its highest rate for nearly 40 years. Normally, the bank aims to keep inflation at a modest 2%.

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May’s figure was even higher than expected, meaning Macklem’s main concern will be preventing high inflation from taking hold.

It is a difficult balancing act. The bank opted to keep rates near zero for the first two years of the pandemic to help stimulate the economy, but creeping inflation forced it to act.

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In March, it raised its rates by 0.25%, then by 0.50% in April and June.

How does this affect the economy?

In general, analysts fear that these oversized increases could plunge the country into a recession.

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Moshe Lander, an economist at Concordia University in Montreal, says a hike of this magnitude is not just a “depressing move” but could also “take some of the starch out of the Canadian economy in the process. “.

Although Lander has reservations about such a big move, he can’t deny that inflation remains stubbornly high despite the bank’s best efforts in recent months.

“And so [the bank has] no choice but to go nuclear and accept this depressing increase,” says Lander.

The risks of such a warmongering movement are worth taking, BMO’s Porter writes.

“Recession calls have become commonplace for the broader economy,” Porter wrote in a recent note to clients. “But these growing risks simply cannot and will not stop the bank from continuing; the risk recession should be a secondary consideration to the reality burning inflation.

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Canadian consumers will soon feel the heat

This reality has been hit Canadians where it hurts – their wallets – for months now.

Unfortunately, while this month’s very strong increase may finally help calm inflation, many Canadians will see their finances take a hit elsewhere, mostly due to debt. When the central bank raises rates, the country’s lenders tend to follow suit.

Canadians are among the most indebted of any advanced economy in the world. And while household wealth has surged during the pandemic, a report by RBC Economics shows that almost 60% of this is simply due to rising real estate values.

The same report shows that household debt is at record highs – again thanks to the “heated real estate market”, which has “led to more mortgage borrowing”. Canadian borrowers must pay an additional $300 billion over pre-pandemic debt levels.

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Beware of landlords

Anyone with a variable rate loan should expect their rates to rise almost immediately. The Financial Consumer Agency of Canada offers some useful examples of how it works.

Take someone who has a mortgage of $278,748 with a current interest rate of 3.1% and 23 years remaining in their repayment period. Their monthly mortgage payment is currently $1,411, but even a 0.50% rate hike would take it to $1,483.

For every 0.50% increase, their mortgage is costing them $72 more in interest each month.

When rate hikes reach three-quarters of a percent or more, “of course, as an individual with a mortgage, I’m not too happy,” Lander says. “But at least I understand what the goal is, and you do what you have to do.”

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Don’t expect relief in the near future

Part of the reason the last three rate hikes haven’t had the effect economists hoped is that some aspects of what fuels inflation are beyond the bank’s control, like Russia’s War in Ukraine or supply chain issues.

Once the bank is able to ease the pressure where it can, Lander says rate hikes will stop. But that shouldn’t happen before the end of the year, since with each announcement, the bank reminds us that it’s not done yet.

And Lander adds that the bank has been pretty clear that consumers need to tighten their belts.

“I’ve seen more than one occasion where they’ve gone to an open mic and said, ‘Hey Canadians…you need to get your debt levels under control,’” Lander said.

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What can Canadians do to offset rising costs?

For most homeowners with variable rate mortgages or HELOC who aren’t overleveraged in their loans, Lander says a few modest changes might be enough to make room to accommodate the increases.

It might look like opting for a staycation instead of a two-week getaway to Europe this summer or reduce your household budget find a few hundred extra dollars a month.

The government too recommend several measures to help you prepare for future increases, such as reducing your expenses, paying off your debts with the highest interest rates, and finding other ways to increase your income.

“The Bank of Canada gave warnings,” says Lander. “And so there’s time for Canadians to, at the margins, adjust their behavior – and that doesn’t require wholesale selling your house.”

This article provides information only and should not be construed as advice. It is provided without warranty of any kind.

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Joan J. Holland