July 10th Interest Rate Commentary

July Rate Hike is Likely But Then Pause…?

The Bank of Canada will meet on Wednesday (July 11th) to decide on its latest move on interest rates next week and many are expecting an increase from 1.25% to 1.50%. But once July’s hike is done, things become less clear as the economy is showing some mixed signals.

*As an aside, this increase will change a lender’s prime rate from 3.45% to 3.7%. This will increase variable rate mortgages and home equity lines of credit by 0.25%.

CIBC and TD’s chief economists think that this will be the last rate hike in a while.

CIBC: “That will be the last piece of the puzzle for a Bank of Canada rate hike in July, but we’re also of the view that economic growth will moderate enough after Q2 to force another extended pause on rates.”
TD: “Given a more cautious outlook and ongoing threat of escalating trade wars, we suspect it will be some time before we see another hike.”

Eitan’s Opinion

Here are some facts that the Bank of Canada has to contend with:

-interest rates has been low for a very long time,
-the economy is doing better over and the government has to increase rates to avoid higher inflation, but…

-for every dollar Canadians make in income, they owe $1.70 in debt,
-every time the BoC raises interest rates, it hurts Canadians,
-household debt is quite large due to all the mortgages and home equity lines of credit we’ve been giving out,
-real estate is 20% of Canadian GDP,
-housing starts are slowing down. Once people stop building as much, the economy will suffer, and
-Red Flag – Equifax reported that they expect more delinquencies in the future as rates rise.

Based on all of these facts, we do know that the rates are going to increase. However, the government is deathly afraid of increasing the rates too much or too quickly…

Also, an increase in the interest rates or a decrease in the demand for housing could send the Canadian economy, whose single largest driver is real estate, into a downward spiral

To dig even further, please see the graph below:

Bank of Canada Prime Rate 25 years
Mortgage Rates for Bank of Canada Prime Rate

We see above that the interest rates from the BoC were around 3.5% from beginning 2000s till 2008. This was during a large real estate boom in the US and Canada. However, quantitative easing (making sure the economy gets back on track) and low rates were implemented after the 2008 meltdown, to stimulate borrowing.

What happened was that mortgage amounts kept increasing because a borrower’s income could increasingly qualify for larger mortgages. In 2008, borrowers could qualify at their contract rate of 4.5%, whereas two years ago borrowers qualified at 2.49%. This was about a 25% increase in affordability. Now however, we’re back up to 5.34%.

What we’re seeing now is a negative effect of boosting the economy; we’re seeing the consequences of too much borrowing and the potential of higher rates creating mortgage defaults.

For all of this, I’m going to call it… I do not see an interest rate rise of more than 1.0% over the next five years. We just won’t be able to absorb this type of increase. 

Please don’t hesitate to contact me if you have any questions or comments!