The Bank of Canada building in Ottawa on June 1, 2010.Chris Wattie/Reuters
The Bank of Canada’s rapid succession of rate hikes over the past two years will continue to reduce the overall disposable income of homeowners with mortgages and weigh on consumer spending even as interest rates start to come down, according to a new paper by economists at the central bank.
The BoC researchers estimate that monthly mortgage payments have risen by an average of 9 per cent since the Bank of Canada began aggressively increasing borrowing costs in March, 2022, to fight inflation. By 2027, average monthly payments will likely be 17 per cent above 2022 levels, the paper contends.
Only around half of homeowners with mortgages have hit reset since the start of the rate-hike cycle. The remainder will renew over the next few years, and many face a steep jump in mortgage costs – especially those who stretched to get into the housing market when interest rates were at record lows during the pandemic.
“This increase directly reduces disposable income. At the peak, the average household with a mortgage will experience a 5 per cent decrease in its level of disposable income,” the economists write. So far, average disposable income for households with mortgages has declined around 3 per cent since 2022.
The paper is a “staff analytical note,” which does not necessarily represent the view of the Bank of Canada’s governing council. But it does highlight the long shadow the bank’s 2022-23 monetary-policy-tightening campaign will cast on the Canadian economy, even as the bank has turned a corner and begun reducing borrowing costs.
The bank cut its policy rate to 4.75 per cent from 5 per cent earlier this month, and officials have said they expect further cuts this year if inflation co-operates. However, interest rates remain in deeply restrictive territory; the policy rate would need to fall roughly two more percentage points (eight typical quarter-percentage-point cuts) to reach a neutral point where it is no longer weighing on economic activity.
The increasing proportion of overall household income going to mortgage payments is expected to weigh on consumer spending.
“A key insight from our analysis is that the downward pressure on consumption from rate hikes could last longer than the rate hike cycle itself,” the researchers write.
“This is because rate hikes not only increase mortgage payments temporarily but also reduce the share of these payments that pay off the principal. A few years of higher rates will therefore lead to a household having a larger remaining balance to repay, negatively affecting borrowers’ consumption in the future.”
Some private-sector economists have argued in recent months that the Canadian economy could still experience a downturn, given the wall of mortgage resets between 2024 and 2026. That’s one reason, they argue, that the Bank of Canada started cutting interest rates earlier than most other central banks, and why it may need to lower rates more quickly than financial markets expect.
The BoC paper stops short of endorsing this view. But it does highlight the continuing drag on household consumption. “We find that unexpected increases in mortgage payments had reduced the consumption of mortgage borrowers by 2.8 per cent, on average, by April 2024. This decline should continue and reach 3.8 per cent in early 2028,” the economists write.