Inflation and how it affects Mortgage Rates
I wanted to take a few minutes to write about inflation and how it connects to mortgage rates and the housing market.
In the most simple terms, inflation is the rise in prices, also known as the decline of purchasing power, over time on a national scale.
The two main causes of inflation are:
An increase in production costs followed by companies responding with an increase in prices
A higher demand for goods and services with consumers willing to pay more for them
Simple enough.
The following sister policies we are going to learn about next are:
Fiscal policy and Monetary Policy.
Fiscal policy refers to how the government achieves sustainable growth through taxation and spending.
Monetary policy is how the government achieves economic growth through controlling money supply.
The government plays a balancing act between these two policies to try to achieve economic harmony and keep inflation under control.
COVID enters the chat.
In the unprecedented times we all lived through where everyone was home, unemployment was high, no one was spending money- the government committed to helping Canadians get through it the best way they knew how. By giving out money.
Let’s visit a few examples:
CEWS - a wage subsidy for employers up to $847 a week per employee (fiscal policy)
CERB - $2,000 a month for individuals (fiscal policy)
CEBA - interest-free, partially forgivable $40,000 loan to businesses (fiscal policy)
Central bank lowered rates to help support economic activity by lowering payments on existing and new loans (monetary policy)
The Bank of Canada (BoC) bought a substantial amount of government bonds (monetary policy)
When the BoC does this its called quantitative easing. BoC buys bonds from the bank, the cash reserves go up and then the bank can lend out this money
Canadians had more money and wanted to spend it on their home, the biggest financial purchase we could get our hands on, at the lowest rates in history. The frenzy to buy NOW was palpable and this pushed many people into the market to take advantage of the low rates and booming housing market.
Property values went up, on average 46% in two years #unbelievable! And they rose because we had, and I quote,:
“a higher demand for goods and services with consumers willing to pay more for them”.
The superficial stimulus we received from the monetary and fiscal policy throughout COVID caused the housing market to go through the roof. Pair that with the other pressures like a war, oil demand and supply chain issues and we have ourselves a party.
A decrease in the value of money (inflation) occurs when we have an increase in the amount of money in the economy (CHECK) followed by an increase in consumer demand (CHECK).
Well, here we are. Inflation has affected the cost of bananas, lumber, to housing and dry cleaning and everything in between.
What do mortgage rates have to do with inflation?
If mortgage rates go up too high, people won’t take out home loans, demand will decrease and prices will fall.
This puts downward pressure on prices and slows the rate of inflation.
This is how:
The Bank of Canada sets a target for the overnight rate, which is the cost for banks to borrow money from each other. They use the overnight rate (monetary policy) to influence the economy.
When the overnight rate goes up, the banks raise their interest rates to cover their costs.
Variable and fixed rates are tied to the overnight rate in different ways.
Variable rates are based on Prime Rate, which is the base interest rate a bank will lend money to cover the overnight rate and their own operating costs. If the overnight rate goes up, prime rate goes up.
Fixed rates follow the bond market. A bond is a loan to a company or government that pays investors a fixed rate of return over a specific time. Inflation is a bond’s worst enemy because the with high inflation, the income you receive from the bond is less valuable over time. When interest rates go up, bond prices go down. As a bond becomes less desirable, the price at which they’re bought and sold change, which affects the interest income yield.
Variable rates have a direct relation to the cost of money and fixed rates have a more indirect relation. We can see that when the overnight rate goes up, fixed and variable rates will also go up.
The housing market was inflated by pandemic gains. The slow down we are seeing, in my opinion, is more of a correction and this adjustment is helping to bring some sanity back to Canadian real estate.
I will end with some good news: Inflation doesn’t last forever. Through aggressive monetary policy to reduce currency supply, inflation ends. Global inflationary forces have begun to ease: global commodity prices are finally starting to fall from their heights, oil prices have come down and supply bottlenecks have begun to improve. This is all a great sign.
Economists are saying it will come back to the target rate of 2% by 2024. That means we may be at the top end of high rates (if not now, very soon) and, as the saying goes… what goes up, must come down.
If you want to have a mortgage check up, I am more than happy to schedule a call or go for a coffee and talk about your specific mortgage.
Chat soon!
Lezah