If anyone thought the end of the pandemic would bring a return to economic normalcy, 2022 has certainly been surprising. In fact, “elephant in the room” seems to be a fitting expression for the current state of affairs (we’ll explain more on this later, keep reading). As inflation is at the forefront of most consumers’ economic worries, let’s first review some recent key market analytics and trends and then explore the less talked-about topic of its impact on Canadian households.
As many are likely already aware, The Bank of Canada has taken its inflation fight to a new level, surprising markets with a 100-bps (1%) rate hike back on July 13th. The Bank is now recognizing that inflationary forces are stronger and more persistent than they previously anticipated. Egged on by spiking fuel and grain prices following the outbreak of war in Ukraine, increasing costs across the board are putting pressure on Canadian families.
But the bigger concern is that inflation expectations continue to rise. Here’s an excerpt from the Bank’s recent Monetary Policy Report:
In other words, if people THINK inflation will be high, they will demand higher wages today. And with the unemployment rate at a record low of just 4.9% and with nearly one million job vacancies, employees have a lot of bargaining power. Consumers and businesses are also more likely to spend more today if they think inflation will remain high. After all, who wants to pay 10% more next year when you can buy that gadget today? This extra demand creates the very inflation that consumers worry about in a self-reinforcing cycle. This is why the Bank of Canada is in automatic tightening mode at the moment. They will continue to hike rates until two things happen:
• Inflation shows signs of moderating
• Expectations of future inflation begin to cool
The Bank of Canada will hike rates until people are more fearful of a recession (something that is becoming more and more talked about in recent weeks) than they are of inflation. Canadian consumers are already getting fearful and pessimistic. The latest consumer confidence readings are near the lows seen in the early days of the pandemic.
What it means: Coupled with the fact that key commodities like oil, natural gas, copper, and other base metals have fallen sharply in recent weeks, we could be seeing early signs that inflation and inflation expectations are starting to roll over. And if that’s the case, it suggests that the worst of this rate-hike cycle is perhaps already behind us. In fact, Alberta’s economy continues to churn out new jobs with employment higher by 46,000 in Q2 compared to Q1. The unemployment rate fell from 6.5% to 4.9% over the past quarter, and Alberta’s unemployment rate was 4.8% in July, down 0.1 percentage points from June and 3.7 percentage points below a year ago.
While most of the country is facing challenging conditions in the resale market, housing market dynamics in Alberta look very solid for now. Alberta’s population was 4,500,917 as of April 1, 2022, an increase of 1.4% from the year prior. That’s an increase of more than 60,000 in the past year from international migrants and population inflows from other provinces as an improving economy and relatively affordable housing lure in workers from other parts of the country (i.e Ontario and British Columbia; wink, wink). Strong population growth supports long-term demand. Housing starts surged 39.8% in the second quarter as developers had the busiest quarter since 2014. Dwellings under construction continue to rise, driven primarily by a big uptick in rental construction.
In the near term, rising rates and deteriorating affordability will continue to constrain demand until affordability is improved, either via falling rates or a further reduction in house prices. So while activity may dampen going forward as the full impact of the Bank of Canada’s recent rate hikes takes hold, the market overall remains on very solid footing.
Alberta – Did You know?
And what about variable mortgage rates you ask? After hitting a 14-year high earlier this year, mortgage growth is showing early signs of topping out. Growth has decelerated sharply in the past two months. Borrowers continue to opt for variable-rate mortgages, which have accounted for 54% of new originations since the start of the year. In part, this is due to what has been a historically large gap between fixed and variable mortgage rates. July’s 100-bps rate hike from the Bank of Canada is helping to narrow that gap, but it still remains well above normal levels.
Benchmark Mortgages Pro Tip: It’s important to recognize that while the term “variable” mortgage is often used interchangeably with the term “adjustable” mortgage, the two are actually very different products. With a true variable mortgage product, the mortgage rate may increase but your payment will not. The payment is “static” or remains the same each month no matter if the mortgage rate fluctuates higher or lower based on your lenders ‘prime rate.” If interest rates rise, a larger portion of the payment would go to cover the interest. Should rates rise to the point that the usual mortgage payment no longer covers the full interest amount due (known as the trigger point) only then will the lender notify you and provide options based on their policy and guidelines. With an adjustable-rate mortgage, similar to a variable rate, your mortgage rate can still fluctuate (either higher or lower); however, so will your payments so that you stay on track to pay your mortgage off within a certain timeframe. Simply put, with an adjustable-rate mortgage if interest rates increase, you can expect that your mortgage payment will go up too. Likewise, should rates decrease, your mortgage payment will go down.
So what is the Elephant in the Room? An “elephant in the room” is an enormous and obvious topic that many want to avoid discussing due to it being uncomfortable with the impact it’s having on the circumstances around us, like our economy, and mortgage rates. While there are several references to the origin of the phrase “elephant in the room” several sources point to it becoming used by the masses in 1984/1985. Interesting, back then 5-year fixed mortgage rates were between 12-13 percent (thank goodness we are not experiencing those rates here in 2022).
For the purposes of this article, the economic elephant in the room boils down to household income inequality and the multiplier effect. Recognizing that the inflation challenges currently facing our country and our pocketbooks, do not have the same impact on a micro level.
In a recent speech, Sharon Kozicki, Deputy Governor acknowledged the significance of household differences:
Low-income workers, for instance, are more likely than high-income workers to lose their jobs in a downturn. Thus, income inequality typically rises in recessions. Low-income workers also tend to consume more of their income, on average. So when a negative shock hits the economy, consumption by low-income people is more likely to fall and to fall proportionately more. The drop in overall demand causes businesses to cut production, which results in more job losses and deepens the downturn. This type of amplification of the initial shock is what we commonly refer to as a multiplier effect. In addition, whenever people feel less secure about their prospects, they tend to boost precautionary savings if they can. The drop in demand from that behaviour adds to the multiplier effect.
Thus it’s clear that no matter the impetus of our current economic uncertainty, be it the pandemic, Russia’s invasion of Ukraine, or any other regional, provincial, national, or international occurrences, we will all experience economic disruptions differently. The Deputy Governor went on to say:
With everyday items such as gas and groceries facing some of the fastest price gains, all households are affected by high inflation. But my colleagues and I are mindful that this is especially painful for those with low incomes, because they tend to spend a greater share of their earnings on such items.
- Start a household budget to keep track of your spending: If you don’t have a budget, you’re not alone. According to the Financial Consumer Agency of Canada (FCAC), less than half of Canadians keep a personal budget. Carefully tracking your expenses, however, can make you more aware of how inflation is impacting you. If you commute by car, seeing how much you spend on gas might be the push you need to start carpooling or think about replacing your old vehicle. If inflation is having an outsized impact on your grocery bill, seeing it in black and white may encourage you to reach for store brands. Besides seeing which parts of your spending are most impacted by inflation, budgeting may make you aware of items that you can either do without or substitute with cheaper alternatives. That gym membership, the premium music, and magazine subscriptions, the frequent food delivery orders – these are the kinds of things that you may want to reduce your spending on.
Don’t know how to start budgeting? Consider beginning with a free app, like FCAC’s Budget Planner. This handy tool allows you to save a budget, compare your situation with other Canadians, and even export spreadsheets to work on offline.
- Consider how you’re managing your existing debts: Where there’s high inflation, high-interest rates usually follow. The Bank of Canada surprised economists by raising its policy rate by a full 1% in July. These rate increases get passed on to Canadians in the form of higher payments on their outstanding debts, including adjustable-rate mortgages and lines of credit. Fortunately, there are some things you can do to mitigate the impact of higher rates. If like many Canadians you use a line of credit to pay for most purchases, try increasing the frequency of your payments. Regularly check your balance and immediately paying off existing purchases will help you track your spending and avoid hefty interest payments that can really add up. If you can afford to do so, consider increasing your mortgage payment to chip away at your principal and reduce the long-term pain if rates remain elevated. If you’re a fixed-rate mortgage holder, getting accustomed to a higher payment will ease the strain of the higher rate you may be faced with at renewal.
The next Bank of Canada meeting is September 7th, and we’ll of course be paying close attention to all the factors influencing their decision. Until then, remember, at any point, we can review your current mortgage and our 5-Star Edmonton Mortgage Team can present you with options that might improve your position – whether that means getting a better rate, getting a mortgage with more flexibility, or consolidating your debt to reduce your cost of borrowing.
P.S. Have you heard about our Sweet Summer Fixed-Rate Mortgage? We’ve got a limited-time offer for a 5-year FIXED mortgage worth considering. We’d love to help you find a solution to your home financing needs; perhaps this one is right for you.
We establish meaningful long-term relationships with clients and help them achieve financial freedom faster with diverse and customized mortgage options. The term “benchmark” originates from the chiseled horizontal marks that surveyors made in stone structures as an established point of reference.
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Mortgage Professionals Canada is a non-profit, national mortgage industry association representing 11,500 individuals and 1,000 companies, including mortgage brokerages, lenders, insurers, and industry service providers. Our members make up the largest and most respected network of mortgage professionals in the country.