Increase in the key interest rate and impact on your finances

Ashleay: Welcome to the “In Your Interest!” podcast from iA Financial Group, where we discuss your need-to-know economic news and how it affects your finances. All this in under 10 minutes. In 1981, the key rate was above 20%. How high will interest rates go? My name is Ashleay and, as always, I'm here with my colleague Sébastien McMahon, our Chief Strategist and Senior Economist at iA Financial Group. So, Sébastien, can you read your crystal ball for us maybe?

Sébastien: Yeah, sure, sure. So, we're recording this on October 26, 2022 and we just had the rate hike by the Bank of Canada. So, another rate hike. So, since the beginning of the year, the leading rate or the key rate, as you said, went from 0.25%, which is just about the lowest level it can go there. They never went to 0%. They stop at 0.25%. Now we're all the way up to 3.75. So there were many hikes. We had hikes of 25, 50, 75 and 100 basis points this year. So that was quite a year. Now, we just had 50 this morning. This just means that the Bank of Canada feels that the fight against inflation, it's not over yet.

Ashleay: I see. And did something surprise you about that 50 basis points?

Sébastien: Yeah, a few things surprised us. So, the first one is that markets and the consensus of economists and ourselves, we were expecting 75 basis points again, so 0.75. So now we're at 3.75, we're expecting the rate to go all the way to 4%. The reason is that the language that we had from the Bank of Canada recently was very, as we say in the field, hawkish, so very aggressive against inflation. They were saying that they need to do more. And inflation, the fight is far from being over. So, we interpreted that as them being very aggressive. Make no mistake, 0.5% is a very aggressive rate hike. But what we find more interesting now, what surprised us is that when we read the statement from the bank, when we read the monetary policy report, when we listen to Mr. Macklem this morning at the press conference, they are starting to focus more on the economic slowdown that's coming and less on the stickiness of inflation. So, it seems that maybe they're starting to see that, you know, we're not done, but we're starting to see the light at the end of the tunnel.

Ashleay: I got you. And is that just here in our country or is it everywhere in the world?

Sébastien: It's pretty much everywhere except China. China, they are dealing with other issues. So, they're cutting rates over there. They're trying to kickstart the Chinese economy. That's the topic maybe for another podcast right there. But the Federal Reserve, so the U.S. central bank, they're hiking quickly, the European Central Bank, the Bank of England. So, all of the central banks are all fighting very strongly against inflation now.

Ashleay: I see. And that means that our mortgage rates will be going up, I suppose. How bad can they go?

Sébastien: Well, that's the million dollar question right now. When you look at the rates that are displayed on the websites of banks, you're seeing something around 6.5, 7%. Now that we just had a hike of 50 basis points, probably will be sliding towards maybe 7.5 or, of course, you can negotiate a lower rate. But we started the year at very low mortgage rates. If you signed for a new mortgage in 2021, maybe you were lucky to have, you know, below 2% rate for five years. Now we're looking at something that's much, much more expensive. So, some tough choices for some families.

Ashleay: I see. And can we think of, like if we go back to the eighties, can we think that we might hit that 15% again?

Sébastien: It would be surprising. In the 1980s, you know, our parents or grandparents like to remind us of how things were. Inflation then was very high. They were trying to, you know, break the back of inflation and this is what happened in the 1980s. Until the early 1990s, we had the emergence of inflation targets of 2%. So the process of bringing inflation from 15-20% to 2% meant that they had to have rates as high as, as you mentioned, but right now, above 5%, we think that would be pretty surprising to see the leading rate break the 5% level.

Ashleay: I got it. And so, is it a good time then to renew your mortgage? Let's say if someone is due like, how do we get out of this?

Sébastien: Well, the best time was early this year. Unfortunately, if, right now you want the predictability of a fixed rate, I would say it's a bit late. But if you want to maybe just sign for shorter contract on fixed, if not, maybe staying variable and waiting until maybe we have rate cuts somewhere, maybe in 2024. I mean, it's hard to predict this far ahead, but that could happen. I would stick with that. But unfortunately, I think we're all in the same boat and there's no magic pill here.

Ashleay: I see. And so, does this mean that a recession is basically inevitable?

Sébastien: I wouldn't say inevitable because we have odds of 70% on our end. So, it's not 100%, but it's very likely. And the Bank of Canada, of course, they're not evil people just trying to cause a recession. They're publishing their forecasts. They're backing up their message by saying that, well, we're doing this. The goal is to tame inflation, but to stop inflation in its tracks we need to cool the economy enough. And they are starting to point towards, you know, close to recession levels in 2023. But on our end, we think it's hard to avoid it.

Ashleay: I see. And so, do you have any tips and tricks for people? Like obviously people won't want to spend more if they're able to. Do you have any other ideas for us?

Sébastien: Yeah, sure. So, you know, the basic stuff. So, you know, the Bank of Canada had a survey recently, they asked that question to people: how do you cope with higher rates, higher inflation and, you know, buying better, buying less, shopping more and not creating, you know, needs that weren't there yesterday because you just see a sexy advertisement or something. So, trying to be better consumers, that's part of the solution. And if you can wait for some important purchases, like buying a house, maybe waiting a few years, that could be a good financial decision.

Ashleay: Right. And does that mean that a housing crash would be inevitable?

Sébastien: Well, a housing crash is not inevitable, but strong headwinds for housing, I think we're already starting to see them. Remember that over the last two years and a half, the price of an average house in Canada went up by about 50%, which is not sustainable. So, you don't want to see just bubbles popping everywhere. And then when they burst, then you have some big issues. So, you want the markets to, you know, when they get too hot to cool off and hiking rates like that from central banks, it helps. But we're already seeing a few things that are concerning. So, we see now that the price of the average house in Canada is slowing down month over month at the fastest pace since we have data on that since 1999. So, over the last few months it was -1.5 and -2.5 and -3.5%. So, if you sum everything together, you're getting closer to -10% already. We hear anecdotal evidence in many regions of the country that, you know, the market just went full stop. And we had data yesterday from the region of Toronto showing that year over year the sales of new houses and condos, they are down by about 90%. So, it means like, we went from lots of volume to almost nothing. And this is important because Canada's economy is very sensitive to housing now, and about 10% of Canada's GDP every year is linked to housing. And when we think about housing, we think about, you know, new houses being built or renovation. But when you think about ownership transfer costs, so the fees surrounding a transaction that if I buy your house or you buy mine, this is about 3% of GDP. And if the market just comes to a stop like it's doing right now, you could see just, you know, like that 2% of GDP just evaporate. So, the housing market just stopping in its tracks could be enough to cause a recession. So now housing is really front and centre.

Ashleay: And real quick, GDP, do you want to explain that?

Sébastien: Yeah, gross domestic product, so that's the quantity, the value of everything that is produced in an economy in a year, so the value of goods and services within the economy.

Ashleay: Gotcha. And so, this does not mean, though, that even if we go into a recession, for example, it does not mean that all of a sudden everyone is poor.

Sébastien: No, no, no. It just means that growth is slowing enough to see even some contraction. And that means that where it's hard to see where growth will come from over the next 12 to 18 months. So, if the economy just does some standstill and contracts somewhat, that qualifies as a recession. So, there are big recessions like 2008, pandemics like 2020, and there are also, you know, some smaller recessions. And if there is one in 2023, we are expecting it to be one of the smaller kinds.

Ashleay: And when will it stop? When will these rates stop going up?

Sébastien: Probably the markets are expecting March 2023 we’d be done with rate hikes. Let's see if the data behaves that way. If inflation is more sticky, let's see if maybe if housing slows down. More importantly than we think, maybe it's going to be before that. But it seems that the sweet spot right now is somewhere, let's say, in Q1 of 2023. So, you know, we're almost there.

Ashleay: So, stay tuned.

Sébastien: Stay tuned.

Ashleay: Now, I hate to say it, but doesn't that fuel the recession in that people don't spend as much?

Sébastien: Yeah, I like to say that a recession is just people keeping money in their pockets. So, if everyone starts to be smarter with their money. Less things, less goods and services bought so that means that this is how, you know, recessions happen.

Ashleay: I see. Well, thank you so much, Sébastien. Again, very informative.

Sébastien: Pleasure.

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