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Rise in interest rates | The bandage technique

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Many consumers would have preferred the Bank of Canada to modulate its interest rate hikes less drastically than it has done since March. Should the central bank have spread its rate hikes over time to spare the devastating shock to those who need to renew their mortgage?

That’s the question we’ve been hearing a lot since the Bank of Canada’s key rate went quite suddenly from 0.25% last March to 3.75% since October 26. It should be noted, however, that the six successive increases in interest rates that we have just absorbed constitute one of the fastest bull cycles since the 1970s.

This is not insignificant and which affects quite directly many households who have to renew their mortgage loan or those who have taken out variable-rate loans who regularly experience steep increases in their monthly payments, as shown by the testimonies collected by my colleague Stéphanie Bérubé.

As we know—the subject has been in the headlines constantly for a year now—the high inflation that has become entrenched in economic activity is also having devastating effects on the everyday lives of citizens and businesses.

With an inflation rate that stood at more than 5% at the start of the year and which crossed the 8% threshold in the summer, something not seen for decades, the Canadian monetary authorities had to resolutely attack to the problem to prevent the inflation of an uncontrolled spiral of prices and wages.

To reduce this inflation, it was therefore necessary to act frontally and use the bandage technique. Everyone knows that when it is necessary to remove a dressing stuck to the skin, the most effective technique, even if it is painful, is to remove it abruptly in one go.

Zip, it hurts, but afterwards you don’t think about it anymore. Gradually removing it, millimeter by millimeter, is a completely useless and ineffective technique. We prolong the pain and the bandage always remains stuck to the skin…

The unbridled inflation that we have been experiencing for a year therefore deserved strong action commensurate with the evil to be fought. By ordering significant hikes of 75 or 100 basis points, the Bank of Canada has undertaken to bring the inflationary curve back to the ground as quickly as possible, while hoping that the economic slowdown will be smooth.

A borrowing strategy

We can see, however, that the monetary authorities are starting to want to temper the scale of future increases, as evidenced by the latest 50-point increase in the Bank of Canada’s key rate.

Last Wednesday, the US Federal Reserve for its part raised its key rate by an additional 75 basis points, but its chairman, Jerome Powell, made it clear that the US central bank was very likely to reduce the pace and the amplitude future increases, starting at the next meeting of its monetary policy committee in December.

The Band-Aid technique therefore seems about to come to the end of its process, but interest rates are not about to start falling. We have a long time to go before we hope for an initial loosening of monetary policy in both Canada and the United States.

When we know that the effect of rate hikes takes at least 12 to 18 months before having a full impact on economic activity, we can clearly see that the situation of relatively high rates will persist as long as inflation does not will not return to the range of 2 to 3% expected by the monetary authorities.

The rate increases of the past nine months, however, directly affect households that have inadvertently taken out a variable-rate mortgage loan. Those who have done so in recent years have, in my opinion, been badly advised by their financial institution.

Since 2020, interest rates have been at exceptionally low levels due to the context of the pandemic which has forced central banks to be particularly accommodating.

It was, in my opinion, the ideal time to take out a long-term fixed rate mortgage, because the rates were not going to remain forever at their level, which was historically among the most advantageous ever offered.

For many homeowners who took out their first mortgage in the late 1980s, the average interest rate was around 11%. The prices were not the same, we agree, but the financial burden in terms of interest payments was still much higher than it is with the “high” rates that we know today .



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