Spring 2022: Prices and rates on the rise… Economist Joaquin Kritz-Lara paints the picture!
Joaquin Kritz

Date

Joaquin is the Chief Economist & Strategist at Numera Analytics, an economics research consultancy. Numera offers macro research and strategy services to institutional investors and multinationals.

 

For people like me, the last two years have been challenging and exciting, as the world economy faced an unprecedented number of shocks. 

The latest in this long list of major macro surprises is the Russia-Ukraine war, which is simultaneously reducing global growth prospects while fueling inflation. 

Inflation in Canada is running at a 3-decade high of 6.7%, and could rise further during the spring as firms pass-on higher wage, energy and materials costs onto consumers (think of those expensive home renos!). 

One worrying trend for policymakers in Ottawa is that most people expect high inflation to last. 

Survey data, for instance, reveals that small and medium businesses believe inflation will remain above 5% one year from now.

 

Why does this matter? 

If businesses expect high inflation, they may raise prices aggressively to shield themselves from profit losses between price adjustment periods (which for many services occur only once per year). 

This then creates a ‘self-fulfilling prophecy’, and breaking this cycle, unfortunately for homebuyers, typically calls for interest rate hikes. Doing so is tricky however, since raising rates too fast can slow the economy. 

For the Bank of Canada (BoC), the incentive to hike is stronger than elsewhere, since Canada is less vulnerable to high oil prices when compared to energy importers like Europe. 

In addition, employment levels in Canada have fully recovered (having returned to their pre-COVID trends), reducing the risk of cutting the recovery short. 

Both factors increase the likelihood of a cycle of rapid hikes, as evidenced by the BoC’s decision to lift policy rates by 0.5% a few weeks ago. 

 

One reasonable scenario, for planning purposes, is for a policy rate of 2.5% by year-end, which should translate into a prime rate of 4.5%. 

This would be the highest reached by such rates since the 2008/09 financial crisis, a period characterized by exceptionally favourable financing conditions. 

Higher prime rates could lower housing demand, as this is the rate used by banks to set the rates on fixed and variable mortgages. 

 

What does this mean for the housing market? 

Low inventories and favourable demographics should continue supporting house prices in large metropolitan areas. As a homebuyer, this means you should prepare for a period of rising financing costs, and thus, my recommendation, in this environment, is to discuss your mortgage strategy (including the repayment structure) early on with your investment advisor.

 

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