Canadian Mortgage Borrowers To Reduce Consumption Even After Rate Cuts: BoC

Canada’s sharp and unexpected rate hikes will continue to produce damage, even after rate cuts. A new staff research note from the Bank of Canada (BoC) shows the overnight rate is much higher than initially anticipated, reducing consumption for mortgage borrowers since the climb began in 2022. Rates are now being slashed and providing relief, but reduced consumption is seen through 2027.

Canadian Interest Rates Are Much Higher Than The BoC Anticipated

Canadian interest costs climbed significantly higher than the central bank had forecast. Researchers show they anticipated rates would be 2 points lower than the observed peak. This was primarily due to an incorrect call on transitory inflation, and liquidity issues from excess government borrowing. 

Source: Bank of Canada. 

Mortgage borrowers feel the pain, and those who haven’t will feel it soon. The BoC estimates the average mortgage payment has climbed 9% since 2022—forecast to climb to 17% by 2027. That’s the year virtually all mortgages will have seen at least one renewal since the end of record-low rates. Increased payments will divert funds from consumption towards servicing this debt—a lot of funds. 

Canadian Households Are Going To Reduce Consumption To Pay Debt

The BoC estimates that higher payments have reduced mortgage borrowers’ consumption by 3% since 2022. As the cycle continues, this is forecast to rise to 5% by 2027. The researchers note that borrowers with more disposable income are less likely to reduce consumption. The additional cash for debt servicing is more likely to be diverted from their savings. 

Good news for the economy, considering last week’s data. It showed that high-income households owe most household credit, and have very lofty savings rates. In contrast, most of the population (80%) owes significantly less than half of all household debt. 

BoC Doesn’t Note If It’s Better Or Worse Than The Alternatives

The study emphasizes that consumption pressure will last far beyond the rate cycle. More interest means less interest paid down, which means future payments will be larger. This will divert more income to debt, in a similar way that accumulating significant debt would reduce income for consumption. 

That raises an important issue—is this better or worse than the alternative scenarios? There’s no estimate on the secondary or tertiary impacts or what would have happened if low rates stuck around much longer. A recent analysis from the US Federal Reserve called this type of analysis “naive” due to its failure to acknowledge that higher rates contained prices. They remind analysts that affordability isn’t just the cost of debt, but also the amount. 

Just a few years ago, the BoC made a similar point on the impact of low rates on home prices. They found that 30 years of falling rates didn’t improve affordability for buyers. Home prices simply adjusted to absorb any new credit introduced, actually making it easier for home prices to rise. 

The BIS, the central bank for central banks, also made a similar point back in 2022. Their analysis warned central banks that maintaining excessively low rates for too long pushed home prices higher. It’s unlikely the BoC missed this, considering its Governor also headed the BIS governors’ council at the time.  

There’s also the initial problem the central bank tried to solve with higher rates—elevated inflation. This impacted every household, not just those with a mortgage. Consumption would have fallen significantly in real terms had inflation not been contained.