Canada’s central bank hiked interest rates yet again as part of its objective to keep inflation near its target of 2%. To achieve this goal, the central bank implements changes in its monetary policy.
This scenario has played out countless times worldwide. Many people, especially mortgage holders and those carrying debt, always found the concept of rate hikes to be puzzling.
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A hot economy, according to central bankers, can be problematic. That’s what they say in their own words:
But if the economy is growing too fast, it could lead to rising inflation. So, we might raise the policy rate, which means: People and businesses pay higher interest on loans and mortgages.
A booming economy is… bad?
If the economy is accelerating too fast, central banks consider this to be a negative outcome as it can lead to elevated levels of inflation. In order to combat inflation, the central bank will raise interest rates which forces people and businesses to pay higher interest rates on their loans and mortgages.
When the economy is hot, businesses are expanding and more people are earning a higher salary, the central bank needs to take action to punish this sort of activity. Sorry middle-class families barely getting by, you now need to pay more on your debt – for the greater good, apparently.
A homeowner lucky enough to secure a five-year variable rate mortgage at 0.9% on a roughly $700,000 home is now paying $1,317 more a month (source). Consider this to be their role in slowing down a booming economy… which likely helped them afford a house in the first place.
WTF: people save more when rates are higher
The Bank of Canada notes that when rates are higher, people “tend to save more and spend less.” But this is odd coming from the same entity that is now forcing families to spend hundreds of dollars more on their mortgage, assuming they are lucky enough to have found a reasonably priced home in the first place.
As you can see in my prior Invezz analysis article, an average household earning an average income is now paying $800 more a month on their mortgage payments compared to the pre-COVID era (remember those good ol times?). Yeah, good luck with that whole saving more concept. Great advice, Bank of Canada Governor Tiff Macklem.
Even those on the higher end of the economic spectrum are struggling to save more money in this environment. Per Bloomberg, one-third of Americans bringing home a cool quarter of a million dollars a year are living paycheck to paycheck.
‘No easy solution’
Invezz analyst Dan Ashmore tells me there is “no easy solution” and central banks, including Canada, must be careful not to hike rates up to the point where it triggers a recession. He notes:
As we have seen inflation softening worldwide over the last couple of months, the market is now beginning to turn its attention towards a potential looming recession as the biggest fear. Mortgage owners are just one subset of the people that will feel the pinch – the price that must be paid to get inflation under control
Ironically enough, I should note that soaring mortgage rates are now the largest contributor to inflation in Canada.
Yet it is important to keep in mind that homeowners facing higher costs have seen the value of their asset rise over the years. That is if they bought their property several years ago as housing prices are down from 2022 levels. Dan adds:
Renters see the price increase and get nothing back. And lower income people pay a higher portion of their salary on food and necessities which is also rising, in some cases at alarming rates. They had no assets to enjoy the inflation pushing up all assets through the last two years.
Source: https://invezz.com/news/2023/01/30/exploring-the-puzzling-logic-behind-canadas-central-bank-policies/