Why all the talk around rising interest rates in Canada?

Over the past few days, Canadian media has been crackling with speculation over the future of interest rates in Canada. With the Bank of Canada holding its overnight interest rate at the effective lower bound of 0.25% as recently as January 20, the sudden explosion of rate-rise paranoia comes as somewhat of a surprise.

Just yesterday, the Huffington Post shared a story detailing how the historic amount of money saved by Canadians during the COVID-19 crisis could lead to a tidal wave of spending that sends the Canadian economy soaring past the 2% inflation target established by the BoC as a benchmark for increasing rates.

Quoted in the story was Scotiabank’s Derek Holt, who warned that the slack currently being seen in Canada’s economy could disappear sooner than most experts are expecting.

“The prudent thing to advise heavily indebted Canadians is to plan their finances around rate hikes commencing considerably sooner than the Bank of Canada has guided even up to last week’s announcements,” Holt wrote last Friday.

The Financial Post ran with Holt’s take on February 01, bolstering it with comments from experts at RBC and CIBC who see Canada’s recent economic performance – output up by approximately 8% annualized in the fourth quarter, 0.7% GDP growth in November; both results almost double what economists were expecting – as a sign of brighter days ahead for the economy.

“If the starting point is better, then an earlier elimination of slack is a natural conclusion,” RBC’s Simon Deeley told the FP.

Comments from a report from CIBC’s Avery Sheffield said that if the Canadian economy experiences “enough demand” in 2021, it “might be closing in on full employment, with additional government spending being offset by an earlier need to hike interest rates to contain inflation.”

Dissenting voices

With COVID-19 still a reliable source of economic tumult, projecting an increase in interest rates based on one or two pieces of positive data so early into 2021 feels like somewhat of a stretch. Dominion Lending Centre’s chief economist Dr. Sherry Cooper says some economists may want to take into consideration one of the glaring weaknesses in Canada’s battle against COVID-19 before getting too ahead of themselves.

“One of the biggest reasons [the Bank of Canada] can’t raise rates this year is the vaccine rollout debacle,” Cooper said. “There is no way everyone who wants a vaccine will get one by September, as the Prime Minister has promised.”

RateSpy founder Robert McLister shares Cooper’s scepticism regarding a rate hike.

“BoC rate hikes in 2021 are as likely as snow in July,” McLister said.

Both McLister and Cooper told MBN that for the Bank of Canada to justify rate increases, its 2% inflation target would not only need to be reached, but sustained.

“If the Bank’s messaging is to be believed, and usually it should be, it wants to see core inflation materially exceed 2% for multiple months before it pulls the trigger on a hike,” McLister said.

Recent homeowners at risk?

2020 was a historic year for real estate sales in Canada, one in which low interest rates played no small part. According to the Canadian Real Estate Association, over 714,000 homes were sold last year, providing critical breathing room for the country’s asphyxiating economy.

With real estate being such an important component of Canada’s fiscal wellbeing, and thousands of Canadians relying on adjustable-rate mortgages to fund their home purchases, could there be pressure on the Bank of Canada to leave rates where they are as a means of both maintaining the housing market’s momentum and avoiding a predicament in which countless homeowners are unable to afford higher mortgage payments?

Cooper and McLister say ‘no’.

“The Bank’s mandate is inflation control, not borrower protection,” McLister said. “People are stress tested at ridiculously high rates these days – 4.79% vs. five-year fixed rates below 1.75%. A one-point run-up in rates would have virtually no effect on defaults for over 99 out of 100 prime borrowers.”

And that’s only if rates increase, a move the Bank of Canada has yet to indicate any appetite for. The BoC, Cooper said, has made it “very clear” that it will “not raise rates before 2023.”