The Bank of Canada hiked its benchmark interest rate by half a percentage point to one per cent on Wednesday, a sign the bank is making good on its pledge to battle runaway inflation.
- Big banks move swiftly to raise their own prime lending rates
The Bank of Canada hiked its benchmark interest rate by half a percentage point to one per cent on Wednesday in its latest move to rein in high inflation.
The bank’s rate impacts Canadian businesses and consumers by influencing the rates they pay and receive on things like mortgages, GICs and savings accounts.
The bank slashed its rate to barely above zero in March of 2020 when the pandemic began.
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While the move helped the economy to weather the unprecedented uncertainty of COVID-19, in recent months, inflation has come roaring back to its highest level in decades, prompting the central bank to start unwinding all that cheap credit.
“Inflation is too high,” Bank of Canada governor Tiff Macklem said at a press conference announcing the news. “We need higher interest rates.”
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Bank of Canada Governor Tiff Macklem says the war in Ukraine is one of the reasons Canada is experiencing higher inflation. 1:46
It’s the second time in as many months that the bank has ratcheted its rate higher, and as such Wednesday’s move is both the bank’s first back-to-back rate hike since 2017, as well as its biggest single hike since the year 2000.
Economists were expecting the move, and with inflation flirting with six per cent, they expect more to come, at least until the central bank’s rate gets up to two per cent — and possibly beyond.
Selling off bonds, too
The rate hike isn’t the only thing the bank is doing to remove stimulus from the economy,
Previously in the pandemic, the bank began a program to buy up bonds as a way to keep money flowing and borrowing costs low. Known as “quantitative easing,” the bank has been signalling for a while that the bond-buying program may be coming to an end, and on Wednesday the bank announced it is now moving in the opposite direction, getting rid of all those bonds on its books as they expire.
“Maturing Government of Canada bonds on the bank’s balance sheet will no longer be replaced and, as a result, the size of the balance sheet will decline over time,” the bank said.
WATCH | Rate hikes alone won’t tame inflation, this economist says:
Bank of Canada rate hikes won’t tame inflation, expert says
Inflation in Canada is mostly due to global forces such as the war in Ukraine and supply chain disruptions, says Frances Donald, global chief economist for Manulife Investment Management. This means interest rate hikes by the Bank of Canada won’t help reduce inflation but could reduce growth. 3:54
That will add to the cost of borrowing, since the the central bank being removed as a guaranteed buyer of all those bonds will force those who issue them to have to pay a higher rate to borrow money.
Those rates were headed higher even before the bank’s decision. The yield on a five-year bond topped 2.7 per cent this week, the highest rate since 2013. Barely a month ago, it was less than 1.5 per cent, and at one point earlier in the pandemic, it bottomed out at below 0.5 per cent.
The bank’s decision to implement a “quantitative tightening” program will push those yields up even further, making fixed-rate mortgages more expensive.
Variable-rate loans, meanwhile, are pegged to the bank’s rate, so they too will be headed higher as a result. Within hours of the central bank’s decision, four of Canada’s biggest lenders — RBC, TD, Scotiabank and BMO — had raised their prime rate by 50 points to match the central bank. The fifth, CIBC, is expected to follow suit.
Harder to buy
Anyone on a fixed rate loan is immune from higher rates for now because they’ve locked in, but one of the biggest impacts of this rate hike will be on first-time buyers, because higher rates will raise the bar for the stress test that calculates how much they are allowed to borrow.
Mortgage broker Leah Zlatkin with Lowestrates.ca says that the exact amount will depend on people’s situations, but in general, every 25-point move in the bank’s rate results in a loss of about $12,000 of purchasing power. Wednesday’s 50-point hike is twice that.
“Because of this people are going to qualify for a little less money than they used to qualify for,” she said in an interview.
While home loans are the most obvious way that interest rates affect Canadians, anyone with debt is likely to feel the pinch.
Other debt more expensive, too
In Edmonton, Michelle and Candace Lister know first-hand how debt loads are usually manageable, right up until they aren’t. While they both make good incomes and own their home, their stable financial life started to unravel after a car accident totalled their vehicle in 2019.
They owed more money on their written-off van than it was worth, so that debt got rolled into a new car loan in 2020.
Then they both contracted COVID-19 in, which resulted in them not being able to work for a while, which caused their incomes to plummet while they were on CERB to the point where they couldn’t keep up with the payments.
“We ended up going further and further into the credit cards, and then it was really difficult to get out,” Michelle told CBC News.
The couple are currently negotiating a settlement with their creditors, but they feel compelled to share their story as a cautionary tale to others about how easy it is to drown in a high-rate environment.
“I think there’s more people than one might imagine … in the same situation,” Michelle said.
Rate hikes ‘good and bad’
Changes to the bank rate tend to impact the housing market in a negative way, but they also have a positive impact on the other side of the ledger for many households. That’s part of why for consumers, rate hikes are “good and bad,” according to Bruce Sellery, CEO of Credit Canada Debt Solutions.
“They are bad in that it’s going to cost you more to borrow money, but they are good in that they are the action that a central bank can take to try and control inflation,” he told CBC News in an interview.
Canada’s inflation rate hit 5.7 per cent last month, and the price of everything from food to housing to gasoline is going up at its fastest pace in decades. “Something needs to be done so that we’re not paying such ridiculous prices for things,” Sellery said.