The Bank of Canada raises its rate to 2.5% — here’s what it means for you

The Bank of Canada raised its benchmark interest rate by the highest amount in more than 20 years, sharply raising the cost of borrowing in a bid to curb runaway inflation.

Canada’s central bank on Wednesday raised its benchmark interest rate by one percentage point to 2.5%. This is the largest one-time rate increase for the bank since 1998.

The bank rate affects the rate Canadians get from their lenders on things like mortgages and lines of credit. Two of Canada’s big banks have already changed their benchmark rates in response, with Royal Bank and TD raising their prime rates from 3.7% to 4.7% Thursday morning.

Other major lenders are expected to follow suit shortly.

All other things being equal, a central bank lowers the lending rate when it wants to stimulate the economy by getting people to borrow and invest. It raises rates when it wants to cool an overheated economy.

After cutting its rate to record lows at the start of the pandemic, the bank has now raised its rate four times since March as part of an aggressive campaign to fight inflation, which hit its highest level in 40 years.

Economists expected the bank to raise its rate by three-quarters of a percentage point, but the full percentage point increase was even higher than those lofty expectations. And even after this record increase, further increases are expected, due to the seriousness of the specter of stubbornly high inflation.

Bank of Canada Governor Tiff Macklem said the bank made the decision to step up its rate-hike campaign because Canadians “are increasingly concerned that high inflation is here to stay. . We can’t let that happen.”

“We are rapidly raising our key interest rate to prevent high inflation from taking hold. If it does, it will be harder for the economy – and for Canadians – to bring inflation down.” , he said, noting that the bank does not expect the official inflation rate to drop to 3% until next year and not return to its 2% target before 2024.

WATCH | The Governor of the Bank of Canada explains why controlling inflation is so important:

Bank of Canada announces 1% interest rate hike

Bank of Canada Governor Tiff Macklem raised the Bank’s benchmark interest rate by one percentage point to 2.5% — the largest one-time increase since 1998 — to combat high inflation.

Big hike justified, says an economist

Economist Stephen Gordon of Laval University says it’s clear the bank miscalculated the speed at which inflation was going to rise and is now trying to correct its course on the fly.

“They’re paying a bit of a catch-up here, and that’s part of why they’re rising so fast,” he said in an interview.

While the size of the hike is out of the norm, he says it was justified given the unprecedented challenges facing the economy today.

“We are in a situation where we have supply chain disruptions, very high oil prices, pent-up demand as a result of the pandemic,” he said.

“We’re in new territory here, so there’s very little to guide us on the path of history. We’re just going to have to feel the way forward.”

The housing market will feel the effects

The impact of higher rates will be felt more directly in the housing market, as variable rate mortgages are closely tied to the central bank rate.

The Canadian housing market has been hot for most of the pandemic, as record rates fueled demand and pushed prices to their highest level ever. But that direction reversed in the first part of this year, as the central bank’s signal that higher rates were ahead took the wind out of the sails of insatiable demand.

Average prices have fallen since March across the country, according to the Canadian Real Estate Association. Wednesday’s rate hike will do nothing to reverse this trend.

Potential home buyers need to have their finances tested to ensure they can withstand higher lending rates, and Wednesday’s rate hike will take that test bar to around 7% for fixed-rate loans and 6 % for variable loans.

If borrowers do not pass the stress test, lenders are forced to reduce the amount they will lend to them until they reach the bar.

Anyone who currently has an adjustable rate loan — and anyone looking to get one to buy — will likely notice their mortgage rates go up almost immediately.

On a $400,000 mortgage amortized over the normal 25-year term, a borrower who takes out a loan at 3% will pay $1,893 per month. But if their rate goes up a full percentage point, like the bank’s rate just did, that monthly payment will go up to $2,104 per month. That’s $211 more each month on their budget.

If the rate increases to 5%, the monthly payment increases to $2,326, which would be more than 22% more than what they were originally paying.

More rate hikes expected

Increases like this are exactly what homeowner Tim Capes was worried about last month when he switched his home loan from a variable rate to a fixed rate mortgage.

“We felt the pain every time the interest rates went up and we got a letter from the bank saying our mortgage would go up a certain amount and the budget would get a little tighter,” he told CBC News in an interview. .

Tim Capes, pictured here holding his infant son Ben, owns a home in Markham, Ontario.  He had an adjustable rate mortgage on the property, but recently decided to switch to a fixed rate loan because he feared interest rates would rise quickly.
Tim Capes holds his infant son, Ben, outside his home in Markham, Ontario. He had an adjustable rate mortgage on the property, but recently decided to switch to a fixed rate loan because he feared interest rates would rise quickly. (Craig Chivers/CBC)

After watching his payment increase each time the central bank raised its rate in March, April and then June, Capes decided to bite the bullet and lock in to a fixed rate that costs him about $700 more per payment than it only paid before, but at least comes with the certainty that it will not change for the next five years.

“I really wish I had done it earlier when rates were even lower because picking a variable in the first place was definitely a mistake,” the Markham, Ont., resident said. “But we finally decided it was a mistake we could afford to correct. So we did.”

Economists expect several more rate hikes, as does Capes.

“As these rate hikes start to happen, it’s a lot easier to know that my mortgage isn’t going up with every rate hike.”

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