Unintended Consequences - Issue 369

The Bank of Canada has pushed the interest rate up another 25 basis points to 5% this past week and have hinted that there may be more to come.

We know the target inflation rate is 2.0% and underlying inflationary pressures are proving to be more resilient than expected according to the Governor of the Bank of Canada.

The BoC has two goals with respect to inflation. First is to slow the growth of demand in the economy and relieve price pressure. Second is to balance the risks of under and over tightening monetary policy.

What we do know is that inflation has decreased from a high of 8% last summer down to 3.4% this month. Not close enough to the targeted rate of 2.0% according to the bank's Governor Tiff Macklin.

The belief is that if they take their foot off the brake now, the current level of demand in the economy would allow the inflation rate to spike back up to a higher level. The counter argument is that because the lag time between rate increases and impact on the economy is not instantaneous, the risk associated with quantitative tightening is higher than the threat of inflation taking off again if rates were left alone.

In a perfect world, this would make sense.

In the real world however, I believe there are a number of variables that play a role that the Bank of Canada may have chosen to ignore or can’t figure out how to factor in.

Consolidation in various industries has been going on for some time. After an economic crisis, in addition to a health crisis like the Covid pandemic, there are opportunities in the marketplace for stronger companies to consolidate weaker, under performing competitors.

This situation has played out post-Covid in a number of industries including the airlines, mining, agriculture and tech fields. How many airlines have disappeared or been absorbed by competitors post covid? These consolidations allow the stronger companies to preserve the increased margins and profits that inflation has helped build. The big 3 grocery stores in Canada have all posted record profits and stronger margins since Covid. If you recall, most companies blamed the increase in prices on broken supply chains, which was valid (Shipping Containers and Your Mortgage). Those issues have disappeared, yet the premiums being passed along to consumers have not.

Additionally, the federal government and, to an extent, the provincial governments are still injecting money into the economy in the form of “targeted support” to use the Prime Minister’s words. It’s much easier for a politician to target support (money) at small groups, like the 11 million people that received their Grocery Rebate, than it is to cut government spending down.

There’s no political “win” for the government if they inflict short term pain in order to meet the long term benefit of stable prices and low inflation. Given the likelihood of another federal election in under 2 years, the governing party is more likely to continue to pump money into the economy for political expediency rather than the overall good of the country.

So what does this all mean for your mortgage and the Guelph housing market?

The median home sales price is down from the peak in 2022 and back in line with November of 2021. Still the median sales price is up 2.7% from June of 2022.

While the BoC can use interest rates to manage demand, it is really a blunt instrument.

When demand for housing is growing because of demographics and immigration, interest rates increases will not have as large of an impact as in other areas of the economy.

This is the antithesis of what one would expect. Increase mortgage rates and demand should drop. To a degree it has because the number of homes being sold has dropped. This past June 190 homes sold in Guelph which is higher than 2022, but well below the levels pre-pandemic when over 200 homes would typically sell in June.

Yet prices remain stubbornly high despite the highest interest rates since 2001.

Back in October, we predicted that home prices would settle down and level out as would interest rates. Neither has happened, and I believe real estate prices increasing again is part of the underlying inflation pressure that has proven to be resilient - as quoted by Tiff Macklin.

How do you damp down demand when there isn’t enough housing - either to buy, or even rent for that matter?

If you are one of the many with a variable rate mortgage that is coming up for renewal, I am still suggesting that a 2-3 year fixed term is the likely answer (your personal situation may vary and I recommend talking to your financial advisor first). The fixed term will give you peace of mind; your payments are fixed and with a positive amortization, and you can wait to see if rates fall back in 2024 or 2025.

This is also a time to consider short term solutions like extending your amortization to make your payments a bit more affordable. Short term being the operative word. The goal should always be to maximize your prepayment options and pay down your mortgage and build equity.

Long-term, I’m not betting that we’ll see significant price decreases in the real estate market. If you are trying to get into the home market, even if you start a rung or two below where you want to be on the property ladder, gets you starting to build equity that in the long term will benefit you.

Parting words…. don’t think short term. Look at where you can be and what life looks like in 5 year windows.

As always, we’re here to answer your questions and provide you with the expertise and guidance you need.

Enjoy the weekend, and thank you for subscribing.

Paul Fitzpatrick

Appointment Calendar: https://calendly.com/homegrouprealty

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