Consumers overestimating how low, and how fast, interest rates will fall: economists

With interest rates likely at or near their peak in Canada, experts say consumers shouldn’t expect rates to return to pre-pandemic levels.

The central bank is more likely to bring its overnight rate to between two and three per cent, though not anytime soon, said David Macdonald, senior economist with the Canadian Centre for Policy Alternatives.

“That’s a ways off. That’s not next year,” he said, adding that consumers may not have fully grasped this yet.

The Bank of Canada on Wednesday held its overnight rate at five per cent, after a breakneck tightening cycle from near-zero in March 2022. The overnight rate affects interest rates offered by financial institutions. 

The Bank of Canada’s overnight rate was 1.75 per cent throughout 2019, before the central bank dropped it to a quarter of a point to support the economy during the onset of the COVID-19 pandemic. 

The central bank is widely expected to hold rates high in the near term as it seeks to quell inflation. But even once rates begin to fall, economists said ultralow rates aren't in the cards.

The Canadian economy, and consumers along with it, is going through an accelerated paradigm shift, said TD chief economist Beata Caranci -- less a gradual shift than a cold glass of water to the face. 

Caranci thinks Canadians are aware that interest rates aren’t going back to pre-pandemic levels, but she also thinks they’re too optimistic about when, and how fast,rates will go down. 

Borrowers have been increasingly opting for shorter terms on their mortgages, hoping rates will be lower in a year or two, she said.

Thatmay well happen, but it’s not a guarantee, she said.

“If you look at our forecast, if you look at the consensus on the street ... Most people have some cuts coming in by the second half of next year. But that's presumed that the economy is weaker than it is today,” said Caranci. 

“One of the points I've been stressing with our clients is, the speed at which rates went up will not be the speed at which they go down.” 

In a report Wednesday, CIBC Capital Markets chief economist Avery Shenfeld said the central bank will likely be able to ease its overnight rate to 3.5 per cent by the end of next year. 

A term that’s often used to describe where the overnight rate may go -- or where it should go -- is the neutral rate. That’s essentially the “Goldilocks” of the central bank’s rate, explained Caranci: “It's an interest rate that allows the economy to grow neither too hot or too cold.”

In an Oct. 5 report, Caranci and senior economist James Orlando wrote that they believe the neutral rate in the U.S. is on the rise due to factors like climate change investment, changing supply chains and higher government deficits. 

“A higher neutral rate means that the current policy rate may not be as restrictive as the (U.S. Federal Reserve) thinks,” they wrote.

A similar trend is at play in Canada, according to Caranci and Orlando, but Canadian consumers' high debt levels mean a lower neutral rate north of the border. 

Prior to the pandemic, rates in Canada and globally had been historically low for years, said Macdonald -- because inflation had been low for decades. 

Rates were as low as half a percentage point during the past decade, including for a two-year stretch between July 2015 and July 2017. Over the past 10 years, the average overnight rate was 1.27 per cent. 

There are downsides to having very low rates, said Macdonald, including the fact that when recession hits, the central bank has very little room to stimulate the economy by lowering rates further. 

Over the years, low rates also contributed to a housing boom, he said. The Bank of Canada’s mandate is to keep inflation in check, Macdonald said, but home prices aren’t included in the Consumer Price Index. 

The seasonally adjusted average price of a home in September was $669,689, according to the Canadian Real Estate Association, a 70 per cent increase from $392,647 a decade earlier and a 216 per cent increase from $211,893 in September 2003. 

This “explosion” in home prices drove substantial wealth inequality over time, said Macdonald, as anyone lucky enough to have their foot in the door at the right time saw their wealth grow, while others were left behind. 

He agrees that Canadians are now in a “difficult period of adjustment,” where household budgets are being eaten up by mortgage costs, rent is on the rise and house prices are expected to moderate. That adjustment has really just begun, he said. 

“We’ve still got a long way to go at these much higher interest rates and much higher inflation.”

-- With files from Nojoud Al Mallees

This report by The Canadian Press was first published Oct. 27, 2023.




Most of Canada’s New Condos Are (Still) Investor Owned: Stat Can

Real estate speculation is a national sport in Canada, but it may have gone over the line. The Statistics Canada (Stat Can) Canadian Housing Statistics Program (CHSP) released data showing the share of newly constructed condos owned by investors in 2021. The data reveals that most units are investor owned, amplifying concerns of financialization and ownership concentration. Both issues lead to inefficient markets that aren’t just difficult for the public, but increase vulnerability in the event of an economic downturn. 

Canadian Real Estate Investor Market Share & Commoditization

Canada has seen the rapid financialization of housing, and that can be an issue. “In the context of housing affordability, concerns about financialization and the concentration of ownership in the real estate market have emerged in recent years,” wrote the CHSP, in the accompanying notes with the data.  

Financialization is when housing is treated as a commodity to trade, rather than serving a need. Everything is commoditized to some degree, but the deeper the financialization the less connected the asset becomes to its use. 

In the case of housing, rather than landlords collecting rental yield, they may start trading the homes as speculative properties detached from any value. That can lead to rents that are no longer connected to incomes, resulting in greater social liabilities. Greater social liabilities tend to produce greater corrections. 

Concentration of ownership can also present a concern when it comes to essentials. A greater share of investors that trade based on financialization, the more distorted markets become. When housing is treated as a commodity disconnected from its need, it’s prone to more violent economic corrections. It’s a problem that was prominent during the Golden Age of Colonialism, and it’s popping up again. Once again, the more disconnected the worse the correction.

Most of Canada’s New Condo Supply Is Investor Owned

Most of Canada’s new condos continue to be investor owned, driven by larger provinces. Investors owned most condo units built after 2016 in Ontario (57.3%) and Nova Scotia (58.8%). It wasn’t quite half in BC (49.3%), but it got closer. Most of Canada’s new supply has been delivered in these provinces, meaning it skews ownership across the country. 

Investors Own Most of Canada’s New Condo Supply

The share of condos built after 2016 that are owned by investors.

*CA includes the five provinces with data from the CHSP. They will be gradually adding more provinces in the coming months.

Source: Stat Can; Better Dwelling

Only two of the tracked provinces have seen major declines in the share of investor-ownership. New Brunswick saw the share of investor owned new condos drop 18.7% to 31.3% in 2021. Manitoba wasn’t as extreme, but still saw a big 9.9% decline to 39.4% of new condos.   

Most housing built after 2016 is investor owned, presenting an ownership concentration issue. The issue becomes even more problematic when you consider this is the share of owners that kept the unit as an investment. Virtually all pre-construction is sold to investors in major markets, distorting them even further.

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