CIBC Deputy Chief Economist Benjamin Tal is urging the Bank of Canada to take a slow and steady approach to raising interest rates in order to avoid wreaking havoc on mortgage debt-laden Canadian households.
In an interview Monday, Tal said that a deft touch is required to ensure the pace of interest rate increases does not push homeowners over the financial edge.
“The number one risk facing the housing market at this point is if the Bank of Canada waits, and waits, and waits, and then starts raising interest rates very quickly in a panic – let’s say in 2023; that would be very devastating for the housing market, if you have a rapid-speed increase in interest rates,” he said.
“So the hope is that they will move early, and slowly, and by doing so, you actually limit the damage in the mortgage market and the housing market. I think that the fact the Bank of Canada is telling us that they will be moving in the second half of 2022, which is much earlier than expected just a few months ago, that’s a very positive sign.”
The Bank of Canada has clearly signaled that it will not raise its benchmark policy rate until the economic recovery from the worst of the pandemic has taken hold, and indicated in its most recent policy decision that it sees that occurring sometime in the latter half of next year.
Rock-bottom interest rates aimed at cushioning the domestic economy from the ravages of the pandemic had the side effect of turbocharging Canadian housing markets. That heat hasn’t been confined to traditional population centres like Toronto and Vancouver – where average home prices exceed $1 million – as work-from-home measures put in place in the early days of the pandemic led many Canadians to look further afield for more space.
That’s led to double-digit price increases in Toronto bedroom communities like Brampton and Oshawa, divorcing those markets from the underlying economic fundamentals of the area.
Those price increases amid historically low rates have led to Canadians securing larger and larger mortgages. Tal said that’s created conditions where homeowners are more sensitive to any increase in rates than ever before.
“Clearly, we have to ask the following question: to what extent are people sensitive to the risk of higher interest rates? And the short answer is now ’very sensitive’,” he said. “It’s a record high level of sensitivity. I estimate that a one per cent increase in interest rates now is about 30-40 per cent more effective than just a few years ago. So the sensitivity of households to higher interest rates has risen.”
Low interest rates and sky-high home prices have increased Canada’s reliance on the residential real estate sector, which now accounts for more than 10 per cent of overall economic output. Tal said that without a steady hand, the Bank of Canada could push Canada into another recession with rash policy moves.
“Every economic recession was helped, if not more than that, by a monetary policy error in which central bankers were raising interest rates too quickly, and you really want to avoid that,” he said.
“We know [inflation] will be rising, we don’t know how short-lived it will be; we know that it will be rising, and if you wait and wait and wait until it’s too late, then you raise interest rates too quickly. So for me, it’s not really the act of raising interest rates, it’s how quickly you will be doing it.”