Over 40% of the economic impact of Canada's interest rate hikes still to come

Over 40% of the economic impact of the Bank of Canada's interest rate hikes still to come

Single-family houses in Vancouver. (Shutterstock)

It appears the Bank of Canada’s policy interest hikes have finally come to an end, with the next moves either being maintaining or cutting the rate.

It chose to maintain the rate at 5% in its October 25, 2023 announcement, which has been the rate since the last increase of 0.25% from 4.75% on July 12, 2023.

Early on in the pandemic, the Bank of Canada lowered the rate to 0.25% as a measure to stimulate the economy amidst the dire economic impact of the pandemic.

This 0.25% rate was maintained for two years and worked as intended — especially with real estate activity, spurring record levels of transactions through cheap mortgages. In the process, however, it also expanded the housing affordability and supply crisis previously centred in Metro Vancouver and Greater Toronto into a nationwide issue.

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When it had become highly apparent in early 2022 that market inflation for consumer goods was becoming a problem, the rate saw its first increase in two years on March 1, 2022, rising from 0.25% to 0.5% to kick off a string of consecutive hikes. It was previously assumed that the 0.25% hike to 4.5% on January 24, 2023, would be the rate’s ceiling in the current cycle, but the Bank of Canada decided to implement two more 0.25% increases in June and July of this year as a continued inflationary measure.

While the low interest rates during the pandemic had the effect of encouraging consumer spending, the high interest rates over much of the past two years have had the opposite effect.

And according to the National Bank of Canada (NBC), not to be confused with the federal bank, the full impact of the policy interest rate hike has yet to be fully seen.

In late October 2023, NBC issued a market bulletin suggesting that, based on its calculations, 42% of the impact of the 10 policy interest rate hikes since March 2022 has yet to be felt.

Higher costs to borrow money are a speed bump for consumer spending, especially household purchasing power.

For example, a growing proportion of household disposable income is now being directed more towards financing monthly interest payments for a home purchase instead of buying goods and services. This is especially the case in parts of the country where housing affordability issues are particularly acute.

High interest rates also impact renters when homeowners increase their rent significantly to help cover higher interest payments, which in effect means the renter has less to spend on consumer goods and services. This is also true of businesses, as it limits their expansion and innovation.

NBC believes the Canadian economy has only seen 58% of the impact of the policy interest rate hikes to date, with the single largest impact felt during the third quarter of 2022. It should be noted that 4% of the current rate resulted from the consecutive rate hikes experienced between March and December 2022.

national bank of canada policy rate hikes consumer spending

Bank of Canada policy interest rate hike’s negative impact on consumer spending. (National Bank of Canada)

It is estimated that the impact of a rate hike on consumption is only entirely felt after eight quarters or two years. With the last rate hike taking place in July 2023, the full impact may not be seen until Summer 2025.

“Given the long lag between interest rate hikes and their full impact on consumption, there is every reason to believe that weakness will continue for some time,” reads the bulletin.

It is now expected Canada will enter a technical recession starting later this year, if not by early 2024.

The Bank of Canada is not expected to begin the process of slashing its policy interest rate until later in 2025 or possibly even in 2025.

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