Today the Bank of Canada (BoC) announced a Prime rate increase of 1% (most economists were forecasting a rate increase of 0.75%), from the previous rate of 1.5% up to 2.5%. The BoC acknowledged that the increase was aggressive, but indicated they decided that it was appropriate to front-load their interest rate increases (move up the timeline on some of the rate increasing they were expecting to do later this year) in an effort to get ahead of inflation (the reports for which always run a month behind).
This is the largest Prime rate increase in over 2 decades, and will have a strong dampening effect on national spending (mostly business spending, but also somewhat from consumers) over the next few months. Many businesses will also adjust their budgets and forecasts for 2023-24, as less spending means less demand for their goods and services. They will respond by reducing their spending on wages (through hiring freezes or layoffs) and inventory (importing less goods), which will further ease inflation in the upcoming business quarters and show up in the data later this year and into 2023.
If this more aggressive rate increase by the BoC goes according to plan, then we should begin to see inflation numbers flatten off and begin to fall later this year. The BoC indicates that they do expect to have to make more Prime rate increases before this cycle of inflation is really over. Hopefully though, the aggressive move today will mean less rate increases in the future and a lower overall peak Prime rate next year.
On that note, a recently released CMHC study predicts a mild recession would result if the BoC raises Prime to 3.5% (so a further 1% increase above today’s level).
So while there is still room for further Prime rate increases to come (we are currently anticipating another 0.5% rate increase in the fall), if the government wants to engineer a “soft landing” and not push into a significant recession they can’t go up too much further. And keep in mind, once inflation numbers do come back down (hopefully by the end of 2024) the BoC will likely start to cut Prime back down a bit to provide some economic stimulation in order to prevent a long-term recession. That’s not to say Prime will get back down to 2021 levels anytime soon, but the BoC would have room to do a couple 0.25% rate drops over 2025 to give businesses a push towards expansion again.
In the meantime, on the real estate side of things we are seeing markets cool across the country as buyers wait to see what comes of these aggressive rate increases. Higher interest rates mean mortgage borrowers qualify for less, reducing their maximum purchase price. So overall there is less money to be spent on buying houses, and that’s going to force sellers to cut their prices or wait longer for the right buyer to come along. Over the next 2 years we expect that real estate markets across the country will become more balanced, as prices drop to meet levels that buyers can now afford.
In the Comox Valley, historically we’ve not seen substantial price drops during economic slowdowns (compared to the larger Vancouver and Toronto area markets) because more of our market is driven by people selling and buying in the same area and we have less ‘speculation’ on new construction. However, we expect that local listings will begin sitting on the market for longer and that sellers will need to become more open to offers that have subject conditions (subject to the sale of a current property, subject to financing, subject to home inspections, etc). We will also likely see more listings expire rather than sell, in cases where the sellers can’t get the price they want and so decide to wait a few years for the next market boom.