With inflation numbers coming in higher than expected fuelled by a number of factors including supply pressures, lockdowns in China and even the war in Ukraine, the BoC has committed to increasing their rate very aggressively until they have achieved their “neutral rate”. The neutral rate is defined as: “the policy rate that will allow the economy to operate at its full potential while keeping inflation at or near the Bank’s 2% target.” This number is typically in the 2% – 3% range.
For variable rate holders, this could mean another 1.50% increase over the next year.
So, although the pace of increases has accelerated, we are sticking to our advice from the previous update: those of you with a discount from prime of 0.75% or better should avoid locking in.
4 – 5 year fixed rates are being offered above 4.00%. As such, if you’re enjoying 0.75% below prime, your rate is currently 2.45% — a further 1.50% increase would see your rate top out at 3.95%, or well below what you would be offered to lock-in now.
Without getting too far into crystal ball territory, historically this kind of aggressive movement on the part of the BoC while working to contain inflation, may also have a negative effect on the economy if it turns out they waited too long and increased too fast. The downside would be a recession wherein typically the BoC would have to consider reducing their rate to keep the economy chugging along.
In other words, we are certainly about to feel a pinch with rates increasing, but that pinch may be relatively short lived before we start a return to a pre COVID rate environment.
A strategy to cope with and make the most of the increases
We’re recommending for some of our clients to go ahead and arbitrarily increase your payments to reflect an interest rate more in line with where we think they are headed (between 4.00-4.50%). While rates remain relatively low, the additional payments will all go towards your principal balance. This will have the effect of reducing your final mortgage balance at maturity (saving on total interest). It will also mean you don’t feel the increases as they happen; you’re already making the higher payment but the higher payments are actually helping you pay the loan down faster.
If you are interested in diving a bit deeper into what we are basing our advice on, scroll down to check out detailed articles from some of our favourite economists and market experts. With all that in mind we are always here to chat. Please don’t hesitate to contact Chris, Steve or Boyce if you have any questions.