I was sitting at a table today and we started talking about the inflation rate. Both of my tablemates felt interest rates were going to head up to 20% again as they did in the 80s. I want to give you my professional opinion on this interesting outlook and why I believe this will not happen.
Inflation: a persistent rise in the average level of prices over time.
Consumer Price Index: tracks how much the average Canadian household spends, and how that changes over time.
The Bank of Canada has limited resources to curb inflation so they raise or lower interest rates to increase or decrease inflation. Their preferred range for inflation is between 1% and 3% with a target of 2% increase in inflation each year.
Why are we experiencing inflationary pressures right now?
COVID - COVID created huge government payouts to its citizens to ease the burden of not being able to work. Although this may have seemed like a good idea at the time and people were certainly in need, printing boatloads of money has had repercussions. People have more income to spend on goods and services.
SUPPLY CHAIN - we heard continually that the supply chain issue was temporary, but it is not temporary. There is a huge imbalance in the economy today. Employees cannot find permanent work and employers can’t find employees. Locally we have seen airport lineups, ferries cancelled, restaurant sections not being available, shortened hours at offices due to lack of staff. Potential employees want permanent full-time, stable employment where they are treated respectfully and paid well.
UKRAINE AND RUSSIA - I personally did not realise how much of Canada's supply of grain, oil seed and corn came from Ukraine. This sudden drop in exports and the Russian EU battle for energy has rocked our market. The biggest challenge for Canada with this is that we really have very little control over the outcome of someone else's challenges.
Base-Line Effects in CPI
That being said, there are some items within our CPI that are not as they appear. For example, the CPI is based on a year over year change and 2020-2021 were COVID years. We are basing 2022 price increases over a 2021 benchmark - challenging to do when how people shopped and travelled dramatically changed. The CPI is based on the percentage of increase from 2022 to 2021. As an example, hotel rooms cost more in 2022 than 2021 because for the most part we weren't travelling.
Substitution, new products, quality changes and online retailers have a large impact on the CPI. How do you compare a laptop purchased in 1995 to one purchased in 2022. The two experiences are completely different. Online shopping has exploded in the last couple of years and online shopping tends to be cheaper.
What you need to know:
When the CPI comes down, it tends to come down fast. This is the CPI index for Canada (blue line) and BC (yellow line) for the past 62 years.
Source: Statscan Consumer Price Index. (Link below)
Another wrinkle in time is that the Office of the Superintendent of Financial Institutions Canada (OSFI) is looking at the bank underwriting guidelines for mortgages with a report due out in April of 2023. Here is what I know from past experience with OSFI. The mortgage underwriting guidelines WILL get tighter. OSFI hates the amount of debt that consumers carry. OSFI did not like the low interest rate environment and the amount of mortgage lending happening in Canada by banks over the past 10 years. Therefore, OSFI will do its best to ensure that the Canadian Banking System remains stable at any cost.
If you are looking at buying a home and are at your maximum ratios, things are going to get even harder to qualify for after April of this year. It also appears it will become much more difficult to purchase an investment property as OSFI is really focusing on income to loan value.
Once rates drop again, housing prices will increase as there will be more demand.
Consider taking a short term 1 year mortgage and ride the interest rate wave down.