In a widely anticipated move, the Bank of Canada held interest rates at 5% on October 25, pointing to slowing economic activity amidst weaker demand and higher borrowing costs. ‘Monetary policy is working, and we want to give it time to do its job’ stated Governor Tiff Macklem in comments made to the press on Wednesday morning. The Bank, however, maintained a cautionary tone stating that ‘progress towards price stability is slow and inflationary risks have increased.’
The Bank began hiking interest rates in March 2022, and since then the prime interest rate has gone from 0.25% to 5.0% in July 2023. The overall inflation rate hit a high of 8.1% in June 2022 and, while it has come down slightly, remains well above the Bank’s target range of 1-3%. The core rate of inflation- which excludes the most volatile items- remains persistently high.
Monetary policy in Canada uses interest rates as the main tool, or mechanism, to keep inflation, in the target range of 2% per year. The tool works primarily via its effect on the demand for goods and services in the economy. As interest rates increase, the credit becomes more expensive, thus consumers and businesses reduce their spending. Overall demand drops which in turn causes prices to drop.
But higher interest rates do not help if inflation is due to supply-side issues. Global supply-chain disruptions, labour shortages, soaring costs of inputs - like energy and fertilizers - and geopolitical risks are what’s driving high costs now.
‘Consumers are also skeptical about whether raising interest rates can lower inflation’ reports the Bank of Canada in their recently released Survey of Consumer Expectations. ‘ While most consumers understand that higher interest rates are intended to reduce inflation, less than half of consumers believe they will.'
Meanwhile, while higher interest rates will not fix the supply-side issues facing the economy, they are certainly impacting Canadians. And this is especially true for Canadians with mortgage debt.
Unlike in the US, where 30-year mortgages are common, Canadian mortgage holders generally, have much shorter terms. Variable rate mortgages and those with a short-term fixed rate (1-3 years) became very popular in 2021 and early 2022 as interest rates were ultra-low and the expectation was that’s where they’d remain. In January 2021, 57% of new mortgages were taken at variable rates and 69% were for terms less than 3 years.
As interest rates have gone up so quickly and dramatically- over 450 basis points in less than 20 months, many Canadian households have had to adjust to much higher interest costs. A recent survey conducted by Angus-Reid, found that ‘the number of mortgage holders struggling with their monthly payment has doubled since March.’
The Bank of Canada acknowledged this risk at the press conference on Wednesday, ‘we are aware that as we approach the next couple of years, we do have a good portion of Canadians who are renewing, and this will impact spending. We pay close attention to this.’
The Leonine Institute, a US-based nonprofit that conducts research on the implementation of Catholic Social Teaching in economic policy, released a policy paper in 2020 on usury and interest rates. According to Levi A. Russell, Chairman and Fellow in Economics at the Institute, most people think of usury as only applying to ‘very high interest loans’, however, the Church’s position can be shown to be that ‘all consumer loans, including mortgage loans, fall within the definition of usury.’
One of the most important Church documents on the issue of usury, was the encyclical Vix Prevenit issued by Pope Benedict XIV in 1745. Since then, many popes have addressed the issue including, most recently, Pope Francis, who in 2018 met with members of Italy’s Anti-Usury Council and appealed for ‘an end to the exclusionary and unfair economy, that kills and reduces people to “tools of a culture of waste”.
In this high inflation, high interest rate environment, the higher cost of living will continue to be a top concern for many Canadian families. The Bank’s projection is that CPI inflation will gradually ease to 2% in 2025. The Bank of Canada’s next interest rate announcement is on December 6.
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