The Bank of Canada hiked its trendsetting interest rate by three-quarters of a percentage point on Wednesday, the latest move by the central bank in its mission to rein in runaway inflation.
After slashing its rate to near zero in 2020 to help stimulate the economy in the early days of the pandemic, Canada’s central bank has moved aggressively to raise lending rates to try to cool red-hot inflation, which has risen to its highest level in decades.
The bank’s rate impacts the rates that Canadian consumers and businesses get from their banks on things like mortgages, lines of credit and savings accounts.
At the start of the year, the bank’s rate was 0.25 per cent. After Wednesday’s move, it’s now at 3.25 per cent. That’s the highest level for the bank’s rate since early 2008, before the financial crisis.
While Canada’s inflation rate eased somewhat last month from its 30-year high of 8.1 per cent, the bank noted in its decision that most of that decline was due to gas prices, while the rest of the economy still saw “a further broadening of price pressures, particularly in services.”
That persistent underlying inflationary pressure is a big reason why “the policy interest rate will need to rise further,” the bank said, noting that it “remains resolute in its commitment to price stability and will continue to take action as required to achieve the two per cent inflation target.”
The move was widely expected by economists who monitor the bank. While the bank has now hiked its rate five times this year, economists think even more rate hikes are coming before the end of this year.
‘Aggressive’ series of hikes
Jimmy Jean, vice-president and chief economist with financial services conglomerate Desjardins Group, says the bank is making it crystal clear that it is committed to raising lending rates for as long as it takes to get inflation back down to below three per cent.
Five large rate hikes in barely six months, “by any historical standard is a very aggressive tightening cycle, but what the bank is saying today is that this is not over,” Jean said in an interview with CBC News on Wednesday.
Jean says it typically takes up to two years for the impact of higher rates to be fully felt in the economy, which means he thinks high rates will stick around through 2023 at least, even if they come at a cost of tipping the economy into recession.
“We’re already having the highest interest rates we’ve had since 2007 and it’s going to be very difficult to think that this won’t have a high impact on consumer budgets and even possibly on things like insolvencies,” he said.
WATCH | Expect even more rate hikes to come, economist says:
The move will mean anyone with a variable rate loan is likely to see their payment change in the coming days to keep up with the central bank’s move. Two of Canada’s biggest banks, RBC and TD, raised their prime lending rates by the same amount the central bank did, effective Thursday. The others are expected to quickly follow suit.
Many mortgage holders have already felt those increases multiple times this year, as rates on variable rate loans have moved from below two per cent at the start of the year to in excess of four and in some cases five per cent today.
‘Trigger rate’ imminent for many loans
A large group of Canadian borrowers that has so far been relatively immune from rate hikes will feel this one, however, because of how those loans are structured.
Most variable rate mortgages give borrowers the option to keep their payment fixed, even if the rate changes. As interest rates increase, the amount of each payment that goes to paying down the principal gets reduced, while more and more goes toward the interest. That extends the length of the loan, even as the size of the regular payment doesn’t increase.
Eventually, that spread becomes so large that the loan payment becomes interest-only, at which point the payment terms have to be adjusted. It’s known as a trigger rate and “every mortgage broker in Canada and every bank … is getting a constant barrage of calls,” about it right now, mortgage broker Ron Butler says.
The exact point a mortgage will be triggered will depend on the loan, but with rates increasing so far and so fast, many of them either already have tripped over the line or are about to.
Butler says as recently as six months ago, it wasn’t hard to get a loan charging about 1.5 per cent. But with five large rate hikes since March, that same loan today is now charging four per cent or likely more.
At that point, the original loan payment isn’t even enough to cover the interest portion — never mind paying down the balance a little.
“Clients who have a variable rate mortgage that have a static payment are worried that eventually they will hit a trigger point in their contract and their payments will increase,” Butler said.
‘I really have to buckle down’
Debbie Henry is one of them. Henry, who lives in the Toronto area, took out a variable rate loan in November of last year, that came with a fixed payment of $805 every two weeks. While her payment hasn’t changed yet, she is aware that her loan has a trigger point, and she’s worried she may soon cross it.
As things stand, she says she thinks her mortgage payment is effectively going entirely to the interest portion, and not paying down any principal at all.
“If it’s at that trigger rate I really have to buckle down,” she told CBC News in an interview. “I don’t want to be anxious about the mortgage because one way or another it’s going to get paid.”
Anshu Khanna has a fixed payment on a variable-rate loan for a property she owns in downtown Toronto, and she says her trigger rate hasn’t been activated yet.
“If it keeps going to a point where they have to raise the actual monthly payment then it’s going to start to pinch for sure,” she told CBC News in an interview. “We’ll see what happens.”
It’s hard to tell exactly how many people are in the same boat, but data from the Bank of Canada suggests that roughly one third of all mortgages in Canada are variable rate loans, but within that, two-thirds of them have a fixed payment.
Canada’s biggest lender, the Royal Bank of Canada, estimated last week that it has about 80,000 home loans on its books that are soon to hit their trigger point. “Our records indicate you may be approaching your Triggering Interest Rate — a moment when your regular payment is no longer enough to cover the interest portion on your mortgage,” the bank told some of its mortgage holders in a recent letter obtained by CBC News.
“If this event occurs, your mortgage payment will automatically increase,” the letter said.
Of those affected, the average payment is likely to increase by about $200 a month, the bank’s chief risk officer Graeme Hepworth said on a call with financial analysts last month to discuss the bank’s quarterly results.