The central bank is more likely to reduce its overnight rate to between 2% and 3%, but not anytime soon, warned David Macdonald, senior economist at the Canadian Center for Policy Alternatives.
“It’s far from imminent. It won’t be next year,” he said, adding that consumers may not yet fully understand this.
The Bank of Canada has imposed an intense tightening cycle on its key interest rate in recent months. While it was still near zero in March 2022, the central bank gradually raised it until it reached 5% in July, but kept it at that level in September and Wednesday this week . The overnight rate affects the interest rates offered by financial institutions.
The Bank of Canada’s overnight rate was 1.75% throughout 2019, before the central bank lowered it to 0.25% to support the economy at the start of the COVID pandemic -19.
The central bank is widely expected to keep rates high in the near term, aiming to keep inflation in check. But even once rates begin to fall, economists say a return to pre-pandemic rates is not feasible.
The Canadian economy and consumers are experiencing an accelerated paradigm shift, said Beata Caranci, chief economist at TD Bank — which has the effect of a glass of cold water in the face.
Caranci says Canadians are aware that interest rates won’t return to pre-pandemic levels, but she also thinks they are overly optimistic about when and how quickly they will fall. .
Borrowers are increasingly opting for shorter terms on their mortgages, hoping rates will be lower in a year or two, she noted.
It could well happen, but it’s not a guarantee, she observed.
“If you look at our forecasts or the consensus on the street … most expect reductions by the second half of next year. But this assumes that the economy will be weaker than it is today,” noted Ms. Caranci.
“One of the points I stress to our clients is that the speed at which rates have gone up is not going to be the speed at which they go down.”
In a report released Wednesday, CIBC Capital Markets chief economist Avery Shenfeld said the central bank would likely be able to lower its key rate to 3.5% by the end of the year next.
Achieving the “Goldilocks” rate
A term often used to describe where the overnight rate could or should go is the “neutral rate.” This is essentially the central bank’s “Goldilocks” rate, Caranci explained. “It’s an interest rate that allows the economy to grow neither too quickly nor too slowly” – neither too hot nor too cold, like the gruel in the fairy tale.
In a report released Oct. 5, Ms. Caranci and senior economist James Orlando wrote that they believed the neutral rate in the United States was rising due to factors including investments in climate change, supply chains and the increase in public deficits.
“A higher neutral rate means that the current policy rate may not be as restrictive as the US Federal Reserve thinks,” they write.
A similar trend is at work in Canada, according to Ms. Caranci and Mr. Orlando, but high debt levels among Canadian consumers translate into a lower neutral rate north of the border.
Before the pandemic, rates in Canada and around the world had been historically low for years, Macdonald noted, because inflation had been low for decades.
Rates have held steady at 0.5% over the past decade, including over a two-year period between July 2015 and July 2017. Over the past ten years, the average policy rate was 1.27%.
There are downsides to having very low interest rates, Macdonald argued. In the event of a recession, in particular, the central bank has very little room to stimulate the economy by lowering rates further.
Over the years, low interest rates have also contributed to a housing boom, he noted. The Bank of Canada’s mandate is to control inflation, but house prices are not included in the consumer price index, he continued.
The seasonally adjusted average price of a home in September was $669,689, according to the Canadian Real Estate Association, an increase of 70% from $392,647 ten years earlier, and a increase of 216% compared to that of $211,893 in September 2003.
This “explosion” in house prices has led to significant wealth inequality over time, Mr Macdonald pointed out, as anyone lucky enough to get their foot in the door at the right time has seen their wealth grow, while others were left behind.
He agrees that Canadians are currently going through a “difficult adjustment period,” where household budgets are being swallowed up by mortgage costs, rents are rising and real estate prices are expected to moderate. This adjustment is actually only just beginning, he warned.
“We still have a long way to go with these much higher interest rates and much higher inflation.”
2023-10-29 14:57:05
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