For the second time in a row, the Bank of Canada (BoC) announced it is increasing it’s Policy Interest rate by 0.25% (up to 5%). This means that most banks will immediately increase their consumer Prime Rate from 6.95% to 7.20% – the highest the Policy Interest rate has been in 22 years (since April 2001).
In its announcement, the BoC indicated that “global inflation is easing, with lower energy prices and a decline in goods price inflation. However, robust demand and tight labour markets are causing persistent inflationary pressures in services.” Last week’s report from Statistics Canada indicated the Canadian economy added 60,000 jobs in June, underscoring that businesses are still seeing strong demand (especially in the services sectors).
While Canada’s inflation rate for May did drop to 3.4% (down from April’s 4.4%) a substantial portion of that decrease was due to a drop in fuel costs. Canadian consumers are still spending at a fast pace and causing high demand in the retail sales and services sectors, and the cost of housing is still going up due to the chronic under-supply of new construction across the country. Adding to the issue of ‘too much demand’, Canada’s record immigration numbers (our population increased by 1.2 million from March 2022 to March 2023) fundamentally means we have more people needing to buy goods, services and housing. In the long run, immigration will be a good thing for our economy – providing more much-needed labour to fill job vacancies – but when a newcomer arrives in Canada the effect on demand happens immediately while the positive effect on the supply-side takes time to unfold.
The BoC’s overriding mandate is to bring inflation down to 2%. Unfortunately, after strong progress from the summer of 2022 through March 2023, inflation has become more stubborn in the last few months and the BoC has re-stated that they are determined to continue pushing it down despite the negative impacts on homeowners and the wider economy.
The BoC’s rate hike today is meant to send a signal to Canadian consumers to slow down our spending, to prioritize essential goods and services but hold off on unnecessary purchases (especially if they’re being paid on credit). People with adjustable rate mortgages and line of credit debts will be hit immediately by the higher interest costs, but even fixed and variable rate mortgages (with a fixed payment) will be impacted soon as their terms come up for renewal and their next term payments rise drastically. Anyone with mortgage debt should be looking ahead now to understand when their current term is up and be planning for how they will afford their monthly payments when they rise substantially.
For example, a person who started a 5 year fixed mortgage in early 2019 may have received a rate of 3.69%. Assuming a mortgage of $500,000 with a 25 year amortization, this person has had monthly payments of $2546 for the last 5 years. At renewal in early 2024, the mortgage balance will be paid down to $433,000, but if interest rates are the same as they are now this client will be renewing for their next 5 year term at around 5.49% and have monthly payments of $2,960. This clients should be planning now for how they will afford an extra $414 per month (almost $5,000 per year) for their mortgage payment so it doesn’t come as a huge financial shock when it hits.
How will this impact me?
When the Bank of Canada increases Prime by 0.25%, it means that the interest rate on variable rate loans will go up. This means that if you have a variable or adjustable rate mortgage or line of credit, your interest costs will increase making your debt more expensive. For mortgages that are adjustable rate (meaning the payments change whenever Prime does), your payments would increase by about $15 per $100,000 of mortgage balance (assuming a 25 year amortization).
It’s always a good idea to stay informed about any changes to the Prime Rate to understand how it may affect your payments. If you aren’t already subscribed, you can sign up to our newsletter for updates directly to your inbox.
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