06/07/2023
Here we go again…..
Bank Of Canada increases interest rates by .25%
For the uninitiated, here’s a quick overview of how interest rates impact inflation and the housing market and why I think this approach may not have the impact that the government is looking to achieve.
✅ When central banks increase interest rates, it becomes more expensive for individuals and businesses to borrow money. This decrease in borrowing activity can lead to a reduction in consumer spending and investment. As a result, the demand for goods and services may decline, causing a slowdown in economic growth. This slowdown in economic activity can help to control inflation by reducing the pressure on prices. Additionally, higher interest rates can make saving more attractive, leading to increased savings and reduced spending, which can also contribute to lower inflation.
🏠Housing Market: Higher interest rates can affect the housing market in several ways:
📈a. Mortgage Rates: The cost of borrowing money for mortgages increases with higher interest rates. As a result, potential homebuyers may find it more expensive to finance a home purchase. This increase in borrowing costs can reduce housing affordability, leading to a decline in demand for homes. Consequently, this decrease in demand can put downward pressure on housing prices.
📉b. Housing Affordability: Higher interest rates can also impact the affordability of existing homeowners with adjustable-rate mortgages or homeowners seeking to refinance. Increased mortgage rates can raise monthly mortgage payments, making it more challenging for homeowners to meet their obligations. This can lead to an increase in mortgage defaults and foreclosures, which can further affect the housing market by increasing the supply of homes for sale.
🧱c. Construction and Investment: Higher interest rates can also affect the construction industry and housing supply. Developers and builders may face increased borrowing costs for financing new construction projects. As a result, they may scale back or delay their plans, leading to a reduction in housing supply. Decreased housing supply, combined with lower demand due to higher borrowing costs, can contribute to a slowdown in the housing market.
Today's inflation is also driven by profiteering. A study conducted by Canadians for Tax Fairness analyzed financial data from publicly traded companies in Canada and found that their average annual sales revenue increased by $174.5 million, while their costs only rose by $16.9 million. This means that 90% of the revenue increase in 2021 resulted from higher profit margins.
The absence of adequate regulations, competition, and low corporate tax rates incentivize corporations to engage in profiteering practices.
Despite the current inflation being attributed to supply issues and profiteering, central banks are still attempting to address it by reducing demand. In other words, central banks aim to tackle inflation by decreasing the amount of money available to individuals. What’s obvious here is that they know that they cannot directly take money away from people, so they achieve this by raising the cost of borrowing money. When interest rates increase, there are fewer borrowers, leading private banks to create less money. The underlying theory is that reduced money circulation results in decreased investment in the economy and higher unemployment. Ideally, this curtails people's purchasing power and slows down the rate of price increases.
However, the challenge lies in the fact that using interest rate adjustments to control prices is akin to steering a large ship with a small paddle. The Bank of Canada, for example, anticipates that it will take around two years to observe the full impact of their actions on the economy.
Historically, central banks have sometimes increased interest rates more aggressively to demonstrate their commitment to price reduction. This is because the immediate effect of their actions primarily lies in influencing people's expectations.
Consequently, central banks have occasionally gone too far, causing significant hardship for workers.
Overall, raising interest rates can help control inflation by reducing spending and investment, but it can also have a dampening effect on the housing market by making borrowing more expensive and reducing housing affordability. These effects can lead to a decrease in demand, lower housing prices, and a slowdown in housing construction and investment.
We are still growing strong economically, but the pace at which we are is something that needs to be focused on and may have short term detrimental effects but long term positive outlook.
Faraz Hussain
Re/max
📱416-333-3438
