What 2022 Has in Store for Inflation and Interest Rates

Wednesday Jan 12th, 2022

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Since the onset of the COVID-19 pandemic, Canadians have been taking advantage of some of the lowest mortgage interest rates in history. 

On March 4, 2020, the Bank of Canada (BoC) made a 50 basis point cut to its mortgage-market influencing overnight rate as the global economy grappled with the arrival of COVID-19, the first cut since 2015. After two additional cuts, the overnight rate sank to 0.25% where it has remained since. 

Now, according to the most recent overnight rate announcement from the BoC on Wednesday, Dec. 8, the current rate is still expected to hold into mid-2022. Adding into the mix, Consumer Price Index (CPI) inflation is anticipated to remain elevated into the first half of 2022. 

Shaun Cathcart, Senior Economist and Director of Housing Data and Market Analysis at the Canadian Real Estate Association (CREA) sheds light on what inflation and interest rates could have in store for us in 2022.

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What changes in interest rates and inflation can we expect this year?

As the Canadian economy continues to recover from the ripple effects of the pandemic, the BoC said in its latest announcement the economy requires “considerable monetary policy support.” For this reason, the bank has chosen to maintain the overnight rate until mid-2022 when the first increase is expected to occur. 

Cathcart explains the decision to raise the overnight rate in the second or third quarter of 2022 has been established for some time now, but is still contingent on future market data. Already, mortgage rates have been rising in recent months like they did in the spring. 

“The bigger question is how many rate hikes are they going to do, and how fast are they going to do them?” said Cathcart.

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The BoC’s decision to hold the overnight rate has also been made so that “economic slack is absorbed” in order to meet a 2% inflation target in 2022. 

The CPI, an indicator of changes for consumer prices, rose 4.7% on an annual basis in October 2021, the largest gain since February 2003. Initially, the BoC expected CPI inflation would die down by the end of 2021, having been elevated around the 3% mark during the summer. However, the BoC revised its forecast in October, predicting these levels would stay high until the first half of 2022 before easing down to 2% in the second half of the year.

“CPI inflation is elevated and the impact of global supply constraints is feeding through to a broader range of goods prices,” according to the December BoC announcement. “The effects of these constraints on prices will likely take some time to work their way through, given existing supply backlogs.”

How could these changes affect mortgages and everyday living?

With the overnight rate anticipated to rise next year, Cathcart says it may prompt some mortgage holders to lock in their rate ahead of time. 

For new mortgage owners, they’re qualifying at almost 300 basis points above the rate they’re getting, he added. In that sense, the mortgage stress test may act as a “major cushion” against rising rates, but this will depend on how the government may choose to adjust it.

“Depending on how much they raise it, if at all, that could impact people’s qualifying for mortgages more than the actual rate they’re getting,” said Cathcart.

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With interest rates having dropped so low over the last two years, some existing mortgage holders may have opted to lock in or renew their mortgage to take advantage of potential savings. Cathcart notes similar to how market activity can be fueled by lower rates, a hike to rates tends to cool things off. 

“That’s definitely going to be a headwind for activity and prices remaining at the level they’re at next year,” he said. “The stress test is actually going to act as a bit of a cushion maybe against that.”

If the BoC must raise rates to control inflation, Cathcart says this makes it more expensive to carry a mortgage. As the BoC is saying they’re expecting inflation to remain high into 2022, this tells Cathcart it could be above their target for next year. 

“If they want to be slow and steady raising interest rates with so much debt out there, it’s not going to take as many interest rate hikes to get the effect that they want as it did in the past. The economy is more sensitive to that,” said Cathcart. 

Thanks to more purchasing power and scarce supply of goods and services, economists from the Royal Bank of Canada (RBC) also predict inflation rates are “likely to remain above central banks’ targets throughout 2022.” 

The rise in inflation has been driven by factors like higher commodity prices, climbing business input costs and policy stimulus, which are expected to ease over time. During the most recent jump in the CPI, Statistics Canada reported price increases for all eight major CPI components, from transportation to shelter costs. The price of energy, meat products, and passenger vehicles recorded some of the most notable yearly increases, rising 25.5%, 9.9% and 6.1% in October respectively amid labour shortages and supply chain challenges. If inflation continues to climb in 2022, it may impact the cost of living for many.

For the most up-to-date insights on how rising interest rates could affect you, ask for the advice of an experienced REALTOR® or mortgage professional.

The information above is for informational purposes only and should not be used as investment or financial advice.

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