Bank of Canada Warns The Era of Low Rates Is Over

Canadians can barely remember the last time rates were this high, but get used to it. Bank of Canada (BoC) deputy governor Paul Beaudry, speaking a day after the rate hike, warned the era of low interest rates is over. They justified the forecast with a slate of reasons that didn’t quite make sense, and will reverse based on a gut feeling. Uh, sure.

Real, Negative, and Neutral Interest Rates 

Understanding the deputy governor’s speech requires understanding three terms. The first is the real rate of interest, which is the inflation adjusted rate. It’s just subtracting the rate of inflation from the interest rate. For example, if you took out a mortgage with a 2% interest rate while inflation was 5%, it would have a -3% interest rate.   

That brings us to the next one, negative real interest rates—when it falls below 0%. Borrowing money is effectively cheaper than holding cash, since inflation erodes the loan. Central banks use negative real rates to drive demand, in an attempt to raise inflation. Hopefully they don’t underestimate inflation when taking this one on. 

The third term is neutral policy rate—the rate where inflation and interest are in harmony. It’s a unicorn that central banks chase, where inflation is at target, and interest rates don’t provide stimulus or become restrictive on borrowing. Everyone has a job, the cost of goods is stable, and the streets are made of rainbows.     

An important side note on the last one is that Canada doesn’t have its own neutral policy rate. It uses the US neutral rate estimate, which seems wreckless for a sovereign issuer of a convertible currency. It might not be clear, but the US is a very different economy with a different need for credit stimulus. The wild and irrational decision to use the US rate contributes to overstimulated Canadians with some of the highest debt loads in the world. 

Long-Term Real Rates Have Been Declining In Advanced Economies

Canada has seen interest rates go down, but until recently they refused to go back up. Deputy governor Beaudry explained that rates have generally been falling across advanced economies, then used some shaky logic to justify the trend. Four key points: 

  1. Higher savings rates as populations age. 

The central bank explained that older households will save more, implying that lower rates are needed to motivate use. 

It’s a chicken and egg situation though, since low rates helped push the average cost of shelter from 17% of household income, to 30% these days. Since the cost of shelter is closely linked to birth rates, perpetually falling interest rates helped drive an aging population in advanced economies.  

  1. China & Other High Savings Economies Joined The Global Economy

China “and other developing countries” with higher savings rates have joined the global economy. The central bank cited the influx of global capital these households are providing has applied downward pressure on rates. 

Fun fact: The term developing country isn’t defined, and is self declared at the World Trade Organization (WTO). Under WTO rules, a developing country gets special provisions for implementing agreed commitments and measures to increase trade. That fact gets more fun the longer you think about it. 

  1. Rising Inequality 

Rising inequality has also been a factor, according to the BoC. They explained that wealthier households tend to save more, creating further downward pressure on real rates. 

Researchers from the Dutch Central bank found that low rates funnel money to the rich. Low rates provide leverage and inflate assets, allowing those with the most assets to capture more of a country’s economy. The BoC also found low rates inflated home prices, furthering inequality as well. But sure, it’s the inequality driving rates lower.  

  1. Fewer Attractive Investment Opportunities

The final major pressure the BoC cited was “the investment puzzle,” or falling productive investment. It’s puzzling to them why advanced economies haven’t invested in innovation, despite cheaper and cheaper capital to fuel those investments. 

They couldn’t nail down why, but they suggested a few reasons such as fewer profitable ventures, decreased competition as players grow, and the shift from physical to virtual asset investment. 

It’s well established that low rates trigger increased market concentration and falling productivity. Firms divert their research capital to essentially buy revenue, while households prefer non-productive investment such as housing. Why risk starting a business when your bungalow is rising $10k/month? But sure, it’s a mystery, B-Money. 

The Era of Low Rates Are Over 

Returning to low rates seen over the past two decades is unlikely, warned the BoC. “The forces that pushed neutral rates lower may have peaked or could change course,” stated the Deputy Governor. 

None of those factors have shown any real sign of changing, but they must feel it coming. Advanced economies won’t age, developing countries will stop providing capital, and despite companies investing less in productivity, they’ll change their mind. Either that or they made 30 years of poor decisions and lost their lead to countries outside of the “advanced” sphere, and are now scrambling to right course. 

“A lot of uncertainty remains. But it’s possible long-term interest rates will be higher in the coming years than what Canadians are used to,” said the Deputy Governor. 


Adding, “The risks appear mostly tilted to the upside. In the Bank’s view, that makes it more likely that long-term real interest rates will remain elevated relative to their pre-pandemic levels than the opposite.”

Though the central bank also said rates would stay low through this year, was criticized by a bank for dismissing its role in driving home prices, used inflation generating tools while they said it was a global phenomenon they couldn’t stop, and hiked rates a few weeks after they said they would “pause” until the fall. 

Higher rates might stick. They might not. In any case, the central bank’s public communications should be taken with a grain of salt under its latest leadership.

12 Comments

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  • Walter T. 10 months ago

    I usually don’t comment on this site. I feel compelled to make an exception.
    I have been in the financial business most of my life.
    The ignorance of Canada’s central bankers boggles the mind. What is even worse, they have played their present policies for the last 20 years, without the slightest hints of understanding that they were wrong. Period. Full stop.
    Canada will suffer for these idiocies for decades to come. The incompetence shown over the years borders on criminal negligence.

  • Chris 10 months ago

    According to statistic Canada the price of houses almost doubled since 2015, but the ratio of household credit market debt to income has remained almost constant at the same time(~185%)! How is this possible?
    According to this site Mayor of Toronto does not qualify for an average house in the city he governs. Yet apparently bidding wars are starting again.
    If one has 25% for down payment in a small “investment” 3 bd. house in Toronto,
    he would have to charge more than $7000 rent per month to break even.
    And yet we are asked to believe that it is an ordinary (albeit foolish) Joe-the-investor who mortgages themselves to a hilt for an investment house and keeps the price high?
    I don’t buy it.
    I really do not think that the interest rate affects the price of houses in Canadian major cities. Don’t count that you will buy house on the cheap. There will come others who can afford to pay more than you, regardless of the rates.

  • YURIY 10 months ago

    Author of this article forgot to clarify reasons for inflation.
    Reason number one!
    Government irresponsible spending! Government sector is growing while private businesses are dying.
    Reason number two.
    Taxes! Carbon tax brings costs of goods and services up! Government control and regulate every aspect of business. Jobs are leaving Canada!

  • Bob Vila 10 months ago

    Absolutely scathing commentary on central bank incompetence. One would hope this article crosses Paul Beaudry’s desk. All the misdirection from BoC seems intentional at this point. Omitting the obvious faults in his argument does not mean it is immune from you pointing them out.

  • Ike 10 months ago

    Bye bye Liberals

  • Dale Ritch 10 months ago

    The ultra low interest rate policies of the BOC have created a real estate bubble which the BOC has now blown to smithereens!

    New condo sales in the GTA have collapsed in the past 10 months soon to be followed by massive construction layoffs.

    This will lead to another great depression in Canada!

    • Cheon 10 months ago

      So? Real estate is unaffordable for most native horns. Average gta home price is 10-11x average gross household income. The peak of the bubble in the late 80’s to early 90’s was 5x.

  • Dar Robbins 10 months ago

    And you believe them?

    • J 10 months ago

      It’s called fundamentals – when there are no more liquidity or qualified buyers for X products. Prices have to go down or a new lower cost product must take its place.

      While record rents put sizeable dent into down-payments for renters, which drags out the slump even longer as those potential buyers are delayed into the first time home buyer market.

      The only salvation is from money laundering players who may put a floor on the slide. However, they’re not stupid to over do their operations to get the financial police all up their business.

      A cliff is coming. If you want/have to to sell, sell soon (call this speculation; I call it math).

  • JCH 10 months ago

    Nah, the real estate bubble will be protected no matter what. Too many vested interests in Canada have too much net worth tied up in RE.

    I’ll bet this kind of ‘rates will stay high’ talk is mostly to try to talk the RE bubble into halting further expansion, (which feeds inflation), by bringing to market some of the properties hanging on by the skin of their teeth for the promised pivot that will save them.

    Then once the market stops rising yet again, they’ll pause further int rate increases, call inflation stable and on its way back to 2%, and get ready to pivot all the way back to zero as soon as the RE market starts to actually deflate more than few pct from present values.

    You can’t unwind a Ponzi, and significantly falling house prices would be an existential threat to gov of Canada, banks, homeowers, retirees etc, so money will be printed and real interest rates will stay negative til the end of time to avoid any retracement of house prices to any sane level.

    Young people should vote with their feet – there’s no opportunity here any more. Time to find a better country, one that rewards hard work with a reasonable cost of living and better quality of life.

  • Omar 10 months ago

    This was all calculated. They have the public over leverage. Have them default. Kill the middle class. Scum bags that work for the elite not for the populations.

  • Andrew Baldwin 10 months ago

    Stephen Puwasi writes: “An important side note on the last one is that Canada doesn’t have its own neutral policy rate. It uses the US neutral rate estimate, which seems wreckless for a sovereign issuer of a convertible currency.” Obviously “reckless” was intended.

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