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.

5 Comments

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  • Reply
    Omar 1 day ago

    That’s the way the cookie crumbles. Just like when the government drove rates lower with state subsidies, borrowers were able to increase consumption and take out bigger loans.

    Markets balance themselves. The questions is usually how fast and violently they need to do it.

  • Reply
    Jason Chau 1 day ago

    Excellent point. The Bank of Canada (and politicians at every level) are worried about the lost consumption that occurs when interest rates rise, but aren’t worried about the lost consumption that occurs when prices rise.

    Canada letting the problem get to the point where the options are “which consumer will purchase less” is why productivity in the country is now in a death spiral.

    • Reply
      Mortgage Guy 1 day ago

      RBC warned about an important issue being ignored—older people don’t consume as much or in the same type of things as young adults. Since they’re focusing on homeowners (often older) and preserving prices, falling consumption is inevitable.

      I can’t find any other news outlet that reported on this issue but it’s a real doozie.

      https://betterdwelling.com/canadian-millennials-are-failing-to-keep-up-putting-the-economy-at-risk-rbc/

      • Reply
        Leslie 1 day ago

        Not sure I agree. I live in a very affluent Vancouver Island town. The vast majority of people spending freely are OLDER, not YOUNGER customers. Decades of benefiting from Canada’s Real Estate Lotto scheme. “buy real estate make millions”. It’s worked for the last 20 years… question is can it continue and at what cost? A young coworker is driving herself into financial ruin between cost of living and education. She literally has ZERO hope for ever attaining financial stability given her lack of inheritance or luck. The discontent is going to be immense and ugly.

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