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A Broken Promise Leads To A Broken Economy

The Bank of Canada has always avoided forecasting rate hikes and rate cuts. It’s always been a closely guarded secret left to speculation – that is, of course, until July 2020. In what might have been the first announcement of its kind in the history of the BoC, Governor Tiff Macklem publicly stated that “interest rates are low and will stay low for a long time.”

The central bank didn’t anticipate having to raise rates until 2023 and for some reason made a choice to communicate that to Canadians. Naturally, Canadians made financial decisions accordingly. Big financial decisions. All on the basis of a promise made by a government institution they knew and trusted.

As we’re now learning, that promise was impossible to keep.

What Happened After That Announcement

As the pandemic raged on, money started pouring into the hands of Canadians. The Trudeau government handed out relief money frivolously, much of it ending up in the hands of high schoolers living with their parents or people who weren’t even living at all.

Saving accounts began to swell up. Interest rates hit rock bottom. With more cash than ever and nowhere to spend it, Canadians were installing pools, renovating their homes, buying up bigger houses and even secondary properties. And why wouldn’t they? Imagine living in a 600 square foot condo without being able to leave. Add in a spouse and maybe a kid into the mix. You can’t pass up the opportunity to borrow money at record low rates – especially when they’re promised to stay low for a very long time. 

That’s when the real estate market started to explode. By 2021, home values in some neighbourhoods had increased by as much as 50% – an outrageous jump in such a small amount of time.

How the Bank of Canada Responded

To put it lightly, they didn’t. The warning signs were all there and the writing was on the wall for the Canadian economy – but they did nothing. They just blindly followed their Core Inflation rate, all in the name of staying true to an irresponsible promise they were never going to be able to keep.

Finally, in March 2022, the first rate hike happened. But the damage was already done. Real estate values increased by yet another 20-35% since December 2021. Supply chains were an absolute mess. The Russia-Ukraine war was in full throttle causing fuel prices to skyrocket. Inflation was getting out of control, but it was too late for rate hikes to make any sort of meaningful impact. 

That’s when the BoC started playing catch-up. Over the next 6 months, from April to September 2022, the overnight rate went up by 3.00% to 3.25%. This directly impacted the Bank Prime rate which increased from 2.45% in mid 2020 to 5.45% as of September 2022 – the biggest increase in history over such a short amount of time. 

Where Do We Go From Here?

The BoC will keep raising rates until they see hard evidence that inflation has reached 2%. In my opinion, this ignores the real economic suffering that Canadian consumers and businesses will face. 

I’m not talking about greedy people who bought huge homes or cottages just for the hell of it – I’m talking about hard working Canadians who made calculated decisions to go with variable rates because they trusted the Bank of Canada. Continuing to raise rates this rapidly might help Canada’s macroeconomic situation in the short term. But in the long term, it’s going to harm the average Canadian homeowner. 

The Bottom Line

I’m sticking with my variable rate, and I’d highly advise you to do the same. Variable rates have a low exit cost capped at 3 months. This is highly competitive next to the interest rate differential (IRD) that applies to most fixed rates, which can cost around 4 times more than variable rates. That’s why a variable rate leaves you with a lot more flexibility.  

Reminder: you’re going to hear about people having to pay mortgage penalties in the $30,000 and $40,000 range. That’s for people choosing fixed rate mortgages in the 5% range. The BIG SIX BANKS use an inflated prepayment penalty formula if you choose to exit your fixed rate mortgage early.   

If you can’t sleep at night and absolutely, positively need to lock into a fixed rate, don’t do it for a 5-year term. Do it for 2 years max so you can reevaluate and re-strategize when rates inevitably come back down in the next 18-24 months.

Your best interest is my only interest. I reply to all questions and I welcome your comments. Like this article? Share with a friend.

Steve Garganis: 416-224-0114;

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