Front Burner - Everything is expensive Part II: Interest rates

Episode Date: July 19, 2022

You’ve heard this here before: Everything is so crazy expensive these days. In May, Canada’s inflation rate was 7.7 per cent, the highest it's been since 1983. Bank of Canada Governor Tiff Macklem warned that the rate is expected to climb higher than eight per cent this week. In response, Canada's central bank raised its benchmark interest rate last week by 100 basis points, or one percentage point, to 2.5 per cent — the biggest hike in more than two decades. Today, CBC business writer Pete Evans explains the impacts this move could have on the debt levels of Canadians, the economy writ large, and the concern that a recession could be just around the corner.

In the Dragon's Den, a simple pitch can lead to a life-changing connection. Watch new episodes of Dragon's Den free on CBC Gem. Brought to you in part by National Angel Capital Organization, empowering Canada's entrepreneurs through angel investment and industry connections. This is a CBC Podcast. Hello, I'm Jamie Poisson. You've heard this here before. Everything is so crazy expensive right now. In May, Canada's inflation rate was 7.7%. That's the highest it's been since 1983, the year B.B. King put out this track.

I'm trying to make a living. I can't save a cent. It takes all of my money just to eat and pay my rent. I got the blues. Got those inflation blues. Now, Canada's inflation blues are going to get even worse. Bank of Canada Governor Tip Macklem has predicted inflation will go up over 8% and stay around there for at least a few more months. So last week, the Bank of Canada did what it usually does to bring down inflation. It raised interest rates.

It is a whopper. I've never seen this before, and I'd have to check the records, but it's up 100 basis points. That means the overnight interest rate by the Bank of Canada is up to 2.5%. That's beyond... It's the biggest hike in more than two decades,

one that is surely going to have impacts on the economy. So today, I'm joined by CBC Business writer Pete Evans to help us understand what those impacts might be. Hey, Pete. Hey. All right, so here we go. I'm hoping you can spell out the implications of this interest rate hike for me today. But I wonder if we should start with the most basic of basics here.

What is the benchmark interest rate that the Bank of Canada has just raised? Right. So the central bank does a lot of things. But the thing that we care about most and the reason they're in the news now is they raise what's called the target for the overnight rate. So that's a bit of a mouthful, but functionally what it is, is it's the rate that banks like the big banks you and I use all the time charge each other for short term overnight loans. So sort of if they have some money in some other account on the Bank of Canada's books or somewhere else, that Bank of Canada rate is what they charge to have that money staying there. It tends to sort of impact other things, but that's functionally what it is. They're changing the rate that banks are charged for very, very short-term loans.

Okay. And what kind of things use the benchmark interest rate? Like, you know, obviously the banks are charged for them. How does that get transferred on to regular people? Sure. So the main one would be probably variable rate mortgages. There's lots of kinds of debt which are going to be impacted by this. But functionally, if you have a variable rate loan from a bank on a mortgage, they charge you something expressed as a gap between whatever their cost of borrowing is and what they give it to you. So if they're charged 1% for the money they're going to give it to you at, let's say, 3%. So when the bank candidate rate goes up, it tends to filter down most directly into variable rate loans. There's no

sort of like law about that. It's not like the big banks have to, from a rate hike, go and raise your rate or lower it, but it just tends to have that sort of indirect impact. And variable rate loans are, not everybody would have them, right? Like a lot of people have mortgages that they've locked into for five years or whatever. Yeah, that's what's known as a fixed rate mortgage. And happily, most people in Canada, the vast majority of anyone who has a mortgage

is a fixed rate loan. So typically those are a little bit higher anyway, because you're sort of paying more voluntarily for the like peace of mind that your rate won't go up. Gotcha. Okay. So we're going to come back to variable rate mortgages when we talk about housing a bit more, but what other kinds of things use the benchmark interest rate? Really any sort of variable rate loan or even a savings account from a bank sometimes. So there's things like home equity lines of credit, certain types of car loans, certain types of savings accounts, anything which is advertised as being sort of linked to the bank's prime rate, which itself is linked to the Bank of Canada rate, is going to feel this in one way or another.

What about credit cards? The vast majority of credit cards in Canada are going to be some sort of fixed rate. So there shouldn't be any direct impact there. Now there's going to be sort of knock-on effects from what's happening in debt markets overall. But it would be pretty, pretty surprising if anyone saw their credit card rate go up from last week's news. so now that we have a sense of what is going to be affected by these rate hikes let's talk about

the size of this rate hike it was a full percentage point i know that that came as a surprise to some and put that in perspective for me, is that a lot? So it is a lot and it's also not a lot. I mean, at the end of the day, you're talking about 1%, which is hard to talk yourself into being a big deal in anything. In this case, it probably was. And that's mostly because of two things. Number one, the rate was so low to begin with.

So the start of the year, the bank's rate was 0.25%, which is, you know, functionally nothing. After the series of the year, the bank's rate was 0.25%, which is, you know, functionally nothing. After the series of rate hikes in March and then April, June, and then the one last week, that rate is now at 2.5%. So it's significantly up from what it was, but at the end of the day, you're still talking about something which is only two and a half percent. It's also a big deal because it shows how serious the bank has taken inflation. Typically, banks like to move in very sort of slow and steady movements. So the bank meets eight times a year and they like to move things in sort of 25 point increments. So, you know, they don't like to sort

of rock the boat too much. They like to sort of give people warning, nudge rates up and down, sit back for a month or two, see what happens, see what the impact is. So the fact that they move by a full percentage point shows you how serious they think the problem of inflation could be. Yeah. And just to just put that into perspective for people, the overall inflation rate hit a 40 year high of 7.7% in June. The Bank of Canada Governor Tiff Macklin indicates that he expects it's actually going to go higher than that, over 8% as early as this week. An increase of this magnitude in one meeting is very unusual. It reflects very unusual economic circumstances. Inflation is nearly 8%, a level not seen in nearly 40 years.

So talk to me about how making it more expensive to borrow money, how raising this benchmark rate should help drive down inflation or, you know, that's the that's the aim. Why? Prices are going up faster than we've seen in decades. It's because of an imbalance in supply and demand. There's a lot of money and dollars and consumer demand out there chasing things, wanting to buy things, and there's not enough supply of them. And that goes from everything from, you know, grocery stores. In many cases, the growing cost of milk, cheese, and other dairy products will be driving up your grocery bill once again. To the gas station.

Gas under $1 dollar 80 for the first time since april this is probably as good as it's going to get after that analyst dan mctague says the demand from low prices will cause things to backfire housing and you know like a vacation so by them sort of raising interest rates it is a bit of a sort of double whammy like we all feel the pinch of inflation it seems counterintuitive and actually kind of mean to sort of raising interest rates, it is a bit of a sort of double whammy. Like we all feel the pinch of inflation. It seems counterintuitive and actually kind of mean to sort of make that worse temporarily by sort of, you know, like adding to the cost of debt on top of the higher cost for everything else that we're seeing. But what the bank's trying to do there is say, listen, bring down inflation by sort of like reducing the demand for some of these products and services. And that will be better in the long run, even if it hurts us a little bit in the short run.

Yeah, and just continuing on that thread that this is going to suck for a lot of people, Macklem said that he doesn't expect inflation to return to the regular target rate until 2024. While we may see a few more months with CPI inflation close to 8%, we expect it to decline later this year, ease to about 3% by the end of next year, and return to the 2% target in 2024. So this isn't necessarily temporary. I mean, that's just what he thinks is going to happen.

And meantime, wages are not going up enough to keep up with inflation. time, like wages are not going up enough to keep up with inflation. Yeah, the bank likes to see inflation in a band between one and three percent, sort of like Goliath's range where one percent's a bit low, but it goes up to two and three percent's a bit high, but they don't worry that much. That's when they sort of tinker at the edges to try to keep inflation in that band between one and three. So inflation right now is at seven point seven. I think it's expected to go up Wednesday of this week. We're thinking it might hit 8% or even more. So that's very, very far outside the bound they like to see.

So he's not wrong in thinking this is not going to be a short-term thing. It's going to take us, you know, certainly the rest of this year, most of next year before we start coming back to a place where the bank might be remotely comfortable with what's happening in inflation. And would that mean that they might move to lower the rates again or? So I was actually looking at this on the Bloomberg term before this. There was this sort of expectation. You love that Bloomberg term. I do. Every time I talk to you, you're on the Bloomberg term.

Yeah, I was actually looking into this. So back in March and even before then, people were sort of warning about, oh, you know, rate hikes are going to come in. They have to do it eventually with inflation going up. Now that they've sort of put in these rate hikes, they've gone from 0.25 up to two and a half the talk is starting to become okay so how high is this going is it going to go to three is it going to go four beyond that you know it's anyone's guess really because it really depends on on what the data shows on what happens out in the economy but there is certainly talk out there that at some point

probably not in the near future but they change direction again to sort of cut the rate when they want to start stimulating the economy again. So I don't know when that's going to be, but it's not out of the realm of possibility. So let's talk a bit more about how exactly this is going to affect people. I want to put some numbers to this. This is a recent note from a BMO economist to investors. The economist estimates that last year the average priced home in Ontario had a monthly mortgage payment of $3,000. So that's already quite high probably. high probably. But now if today's mortgage rate hits 4.5%, that same home is costing $4,700 a month. So for people who haven't locked into their mortgages, that's quite an enormous jump here.

Yeah. I mean, those people are in my email inbox every single day. Like a $1,700 jump and the cost of anything that you have to pay on a regular basis is not nothing to sneeze at. I mean, people are really, really feeling that. And basically your choices are, OK, so stop doing this, sell your house, get out, or cut back somewhere else to find the money to come up with that extra cost. The Bank of Canada is warning that a reckoning is coming. Those low rates that helped some buyers barely squeeze into the market with relatively affordable payments are starting a long upward trend. So yeah, those numbers sound plausibly correct to me in that,

you know, for most of the pandemic, we had record low interest rates. They had slashed them to sort of encourage people to borrow and invest and sort of keep the economy going through this once in a century pandemic. And somewhere in the last six months to a year or so, that sort of direction changed and the sort of excess demand in the last six months to a year or so, that sort of direction changed and the sort of excess demand in the system caused this inflation problem. So basically, if you bought a house several years ago and you're on a variable rate loan, you're probably noticing that your monthly payment's going up, but you probably have enough sort of equity in the house. You probably paid down part of it that you're not going to feel it directly. It's hard to come up

with that extra 1700 bucks or whatever it is every month. But at the end of the day, you're not sort of teetering over the edge. The ones who are really, really feeling this the most will be anyone who bought in, let's say, the first quarter of the year, sometime in that January to April period. Yeah, when prices were just out of control. Right. Prices were high and rates were low so you sort of stretched and it made a you know eight hundred thousand dollar mortgage look affordable now they probably might be having is you know your eight hundred thousand dollar mortgage might be on a house that's only worth let's say seven hundred thousand dollars and your monthly payment to cover it's

gone up too so you're sort of stuck between this rock and a hard place saying how do i get out of this and there are no easy answers there and And the market, the housing market, what this is doing to the housing market is that it is cooling it somewhat, which is hard for some people who might be now stuck paying much higher mortgages than they anticipated now have a house that is worth less than what they paid for. Yeah, I was crunching the numbers just last week. And on average, the average house price in Canada is down by about 15% across the country since about February or March. So, you know, in some places more, like sort of in places in and around Alberta,

generally doing better because they're sort of flush with oil cash right now. But yeah, most markets, especially in sort of suburbs in and around Toronto and Vancouver, where the gains in the pandemic were the biggest to begin with, prices are down sharply from what they were before. Now, they're especially down on the sales side, which means like the volume of home sales is falling off a cliff because, you know, functionally anyone buying a house right now, there's so much uncertainty that if you're buying and selling, you must really, really need to be buying and selling. No one's sitting there thinking, oh, my neighbor made easy money. I'll just do it. It'll be fine. Yeah, gonna give this be buying and selling. No one's sitting there thinking, oh, my neighbor made easy money. I'll just do it. It'll be fine. Gonna give this a shot.

Yeah, yeah. Yeah, basically, if you're buying or selling a house right now, it's because you really have to because of your life, something's happened. And so what's happening is basically buyers who were seeing sort of bidding wars before, like, you know, you'd show up,

the house is listed at 600K, you talk yourself into 700K and the house sells for 800K and you feel like a dummy for missing out. They're getting a lot choosier right now. So they're saying, yeah, maybe that house isn't worth whatever the person is going to charge for. And hey, maybe that house will be even cheaper next month. So I'm going to sit on the sidelines and wait because I don't need to buy right now.

Right. The double whammy would be for buyers who have been sitting on the sidelines for years. They're now seeing, you know, they got pre-approved in January and the lender said, OK, yeah, sure. We'll lend you $300,000 and it's going to cost you $2,000 a month. That mortgage rate, the lender's still saying, yeah, we're still going to lend you $300,000, but it's now going to cost you $2,500 a month or $3,000 a month. So, so like whatever gains they're making on the sort of price affordability side, they're, they're losing from the increase of the mortgage rate. So yeah, it's a tough place to be. Yeah. It's a tricky situation. And people who aren't homeowners, not only do they now have to contend with higher interest rates, but it's

probably worth saying here that the house prices, they're certainly not falling at this point back to what they were even just a few years ago, like pre-pandemic. like a 15% drop is, you know, I guess a good thing if you're looking for a house, but like if houses have gone up 40%, you know, that's not so great for you. In the Dragon's Den, a simple pitch can lead to a life-changing connection. Watch new episodes of Dragon's Den free on CBC Gem. Brought to you in part by National Angel Capital Organization. Empowering Canada's entrepreneurs through angel investment and industry connections. Hi, it's Ramit Sethi here.

You may have seen my money show on Netflix. I've been talking about money for 20 years. I've talked to millions of people and I have some startling numbers to share with you. Did you know that of the people I speak to, 50% of them do not know their own household income? That's not a typo, 50%. That's because money is confusing. In my new book and podcast, Money for Couples, I help you and your partner create a financial vision together. To listen to this podcast, just search for Money for Couples. I help you and your partner create a financial vision together. To listen to this podcast, just search for Money for Couples. Moving on from mortgages, we talked earlier about how these rate hikes are going to affect

other things like maybe a car loan, a line of credit. So perhaps somebody in the last six months or so took out a line of credit to do a renovation on their house. And Canada, as we talked about on the show before, is a country with quite a bit of consumer debt. Canadians dedicate more income to debt payments than any other G7 country. And so Pete, what are experts that you're talking to saying about this? Like, are they worried that people are not going to be able to make their car payments, their debt payments? So there's one, like, fundamental difference between something like housing debt and some of the consumer debts you're talking about. And mainly it's that, especially in Canada, people will do literally whatever it takes to pay their mortgage. So, like, they will cut back. They'll sell stuff. They'll get a side hustle. They'll do whatever it takes because they think, you So like they will cut back. They'll sell stuff.

They'll get a side hustle. They'll do whatever it takes because they think, you know, this is my house. It's going to go up. I got to keep this, keep those payments going. So I still stay on the title here. Everything else is for better or for worse, a consumer good, right? So everything, you know, like you might say, oh, I need my car to go to work, whatever else. But ultimately, like there's a certain point at which you say, listen, this is not worth it for me.

And you do something like you take transit or you walk, you bike, you take whatever it is. And that goes down to everything else you spend money on, like, you know, something like a credit card. Like even if you're sort of able to stay on top, you know, like you don't like it, but your mortgage has gone up by 500 bucks, but you're finding the way to sort of stay on top. You're not going to lose your home. That 500,,000 extra per month comes from somewhere, right? So maybe it's from your restaurant budget. Maybe it's from your clothing budget. You're going to cancel that vacation.

So that's consumer spending. So let's say I don't have a mortgage or it's fixed rate and I feel like, you know, I'm basically immune from this rate hike so far. You feel on the other end because everyone else in the economy starts to sort of cut back and that's, you know, that's going to hurt the local small business, going to hurt local grocery store, whatever it is. Yeah. And let's talk about that a bit more because our producer, Lauren, she spoke with David McDonald. He's a senior economist with the Canadian Center for Policy Alternatives. He did this historical analysis to see how these

rapid rate hikes have worked in the past. And what he had to say was pretty grim. What everybody wants is a soft landing, which is to say inflation goes back to 2%. We don't get a recession, things go back to normal. My question was, historically speaking, has this ever happened before? Unfortunately, while we have seen a decrease in inflation of that amount, we've seen it three times over the course of our recent history, it's always happened with a recession. And it's always happened with the Bank of Canada hiking interest rates prior to that recession.

What that means is that interest rates as a tool for decreasing inflation, they're effective at decreasing inflation, but at terrible cost. On average, you'd see the equivalent job losses today, 150,000 jobs. So that's a lot of collateral damage of using interest rates to decrease inflation. So look, an average of 850,000 job losses is no small thing. So what if this attempt to control inflation turns into a recession? Yeah, I'm not going to minimize that. I know David, and he's a very smart guy. And I'm not going to say that those 850,000 jobs lost or a bit less or a bit more don't matter. They certainly matter if you're

one of those people in that group. They certainly matter if you are the factory owner who closed down because your line of credit went up and you couldn't afford to employ these 1500 people, whatever. That's a very, very real sort of option on the table. Like economists like to talk about the soft landing, which is sort of like trying to have your cake and eat it too, sort of saying, you know, let's get rid of the bad parts of high inflation, but let's do it in as painlessly a way as we can. So I'm not going to say that's impossible, but the higher this number gets, the harder that's going to be to pull that off. And, you know, what the bank is trying to navigate there is say, you know, like, how can we fix this inflation problem without causing a huge problem somewhere else? So, you know, it might

result in a small, hopefully brief, hopefully short recession, which basically means the economy contracts, it gets smaller for a while, it might result in some jobs being lost. Now, you know, the good news there is that our jobless rate has literally never been lower than it is right now. So if there was ever a time that we could afford to sort of absorb another million job seekers, it's now. I mean, most of the numbers that we see in most of the businesses and economies we talk to say the problem right now is not sort of joblessness. It's actually a lack of workers. Like there aren't enough sort of qualified people to like fill the jobs. I mean, like look around at what's happening in airports and passport offices right now. And, you know, like those are examples of a sort of a labor market that's out of whack.

You know, the alternative is to do nothing and just let sort of inflation run wild and sort itself out, which would have all kinds of negative impacts, which we can't even sort of think about right now, because we're only starting to feel them right now. One question I did have for you is, and we've talked about this, like, we know that the inflation we're seeing, not all of it is like, because of domestic causes, like Russia's invasion of Ukraine, the lasting effect of the pandemic on supply chains. like Russia's invasion of Ukraine, the lasting effect of the pandemic on supply chains. So is it also possible that hiking baseline interest rates domestically is even going to work because some of this stuff is completely out of the control of the Bank of Canada? Like by itself, inflation has to and will come down.

Even if the Bank of Canada doesn't do very much or does the wrong thing, the nature of inflation is that, you know, when it comes on the upswing and hits a certain peak, something called demand destruction happens. That basically is a fancy term for saying, you know, people stop paying for things. You know, if gas goes from $0.80 a liter to $2, everyone's kind of like, oh, this is crazy. I'll drive less, but I'll still fill up. If gas goes to $3 or $4 or $5, you just stop buying that, right? So a lot of these sort of like commodity inputs, we're already seeing they're down from their peaks. I'll drive less, but I'll still fill up. If gas goes to three or four or five, you just stop buying that, right?

So a lot of these sort of like commodity inputs, we're already seeing they're down from their peaks. Pete, but before we go, one thing that I do want to talk to you about is that if I am an indebted person right now, I feel like people are probably feeling frustrated and maybe led astray here. Back in July 2020, I remember Tiff Macklin specifically said, and I'm quoting here, interest rates are very low and they're going to be there for a long time. We recognize that... He reiterated this saying, quote... If you've got a mortgage or if you're considering to make a major purchase or you're a business and you're considering making an investment, you can be confident that interest rates will be low for a long time. And it's quite a change of heart here. So there's a lot to unpack there.

I'd say sort of two things. In June or 2020, whenever that was in the sort of the scary early days of the pandemic, the central bank governor said something to calm the markets, which is like functionally translates English as everyone relax. Like, it's fine. Don't worry about losing your house to a mortgage hike right now. Like, we're going to keep things low for as long as it takes for a long time. So when I think back to what all kinds of policymakers were telling us back in the summer of 2020, you know, things changed, like the situation changed and they reacted to what was happening out there in the real world. You know, that was more than two years ago. He was saying it's going to be there for a long time. Yes, they're up higher than they were then, but I'll give him a pass for responding to this once in a century pandemic by doing something sort of off the books and then

changing his mind and sort of like course correcting, maybe even overcompensating the other way. The other thing to remember in all this is that even after last week's rate hike, rates are cheap. I mean, like we started this off by saying the bank candidate's rate is now 2.5%. Find anyone who had a mortgage in the 1970s or 1980s, and they will literally be incapable of not telling you about how their mortgage back then was 15% or 17% or 18% or 20% in some cases. So, you know, by any historic metric,

yes, it's higher than it was, having gone from 0.25 up to 1 and then 1.5 and 2 and now 2.5. If you look back over a long enough time frame over decades, interest rates are still very, very cheap. Hmm, okay. Pete, thank you, as always.

No problem. All right, that is all for today. I'm Jamie Poisson. Thanks so much for listening. Talk to you tomorrow. For more CBC Podcasts, go to cbc.ca slash podcasts.