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By Mark Kerzner, President & CEO TMG The Mortgage Group

So, they have finally gone ahead and done it.

The Bank of Canada has decided to increase rates, ending months of speculation as to when the Bank would start this new rate-hike cycle.

Growing concerns about a 30-year high in inflation and the continuing rapidly increasing home values are two key factors that have caused the Bank to act now.

Nearly two-thirds of businesses expect inflation to stay above the Bank of Canada’s neutral rate of 3% for at least the next two years, and the Home Price Index is up 26% year-over-year, according to the Canadian Real Estate Association (CREA).

With the economy at full employment and inflation surging, we feel that immediate policy tightening is appropriate even in the face of an Omicron surge," strategists Warren Lovely and Taylor Schleich (National Bank of Canada) told clients in a report published in January.

Former Quebec Premier Jean Charest agrees. “They need to stop inflation before it [runs] its course, otherwise they’ll have bigger problems down the road,” he said.

“That’s the lesson we learned from the 70s and the 80s: if you don’t move decisively at the beginning, you pay a very, very high price later on.”

The last time the Bank of Canada raised its overnight rate was in October 2018, when they increased it 25 basis points to 1.75% citing a “strong economic outlook and overall financial conditions (that) remain accommodative.” At that time, the Canadian dollar was approximately 76.5 cents (vs USD) and core inflation was 2.2%.

As of this writing, the Canadian dollar is trading at just under 79 cents (US) and core inflation is now above 3%. Inflation no longer appears to be transitory and the market was looking for a response.

In a recent blog post, industry expert David Larock posted: “The experience of hotter and stickier inflation has caused both bond-market investors and the wider public to lose confidence in our central bankers.”

Larock says the concern is that if consumers lose faith in the Bank’s ability to keep inflation contained, they may start accelerating their purchase plans to avoid future price increases, in which increases demand and pushes prices even higher.

“The longer inflation persists, the more likely it becomes that workers will push for higher wages to compensate for their reduced purchasing power,” he adds. “This engenders a self-reinforcing cycle, where the fear of higher inflation causes it to materialize.”

We have heard many experts calling for action that would help us achieve a ‘soft landing,’  but how you orchestrate that is the other question that usually leads to experts pontificating both the numbers and the aggregate amount of rate increases they are anticipating in the year ahead. Given the low-rate environment and elevated household debt, many suggest the Bank won’t need as many increases to achieve the same outcome needed in previous cycles.

Since the Bank of Canada raised rates ahead of the U.S. Fed, there are potential implications for the strength of the Canadian dollar, which then has trickle-down effects on exports and potentially the economy as a whole. Are we to understand that the Bank of Canada no longer believes that current inflation levels are transitory, or are they counting on continued economic growth and spending?

While the Bank of Canada made the first monetary policy adjustment, this doesn’t mean they won’t be looking to the Fed for some future guidance.

The Bank of Canada needs to keep a very vigilant eye on the impact that higher rates will have on those with variable-rate mortgages and lines of credit, as well as overall borrowing costs. Our governments, which have added considerable debt to their balance sheets these past two years, are not immune from increased carrying costs on their outstanding balances.

It seems like just a short time ago, in March 2020, when the Bank of Canada reacted to the global pandemic with the swift action of a 150-bps rate cut. Now, they need to reconcile the economy being so tough on certain industries, such as restaurants, tourism and hospitality, and advantageous for other sectors, which has led to increased spending and inflation. In addition, they need to manage the increase in carrying costs for so many against the record-setting increases in home prices and household debt.

Perhaps it’s because this will be the first prime rate increase faced by so many recent first-time homebuyers, or perhaps it is due to the fact that there are confusing and mixed messages to navigate, but it seems the anticipation of this rate increase has garnered a lot of attention recently.

Given elevated debt levels and the uncertainty surrounding the inflation outlook, the Bank of Canada and borrowers alike will be keeping a close eye on future rate increases throughout 2022.