After what for many people has seemed like an eternity, the Bank of Canada announced an interest rate reduction effective for June 2024. It hasn’t been an eternity; rates started increasing in March of 2022 and peaked at 5%, with that rate being reduced by .25% in the latest announcement. The rapid increase from historically low levels was the Bank of Canada’s main tool in fighting back against inflation, so with that rate normalizing recently, they now feel comfortable reducing rates. Have you ever thought about how the Bank of Canada makes its decisions? What about how they affect your daily life? Let’s take a few minutes to try to answer these questions.
In This Article:
- The Role of the Bank of Canada
- Why Do I Care About Monetary Policy?
- How can Working with Strata Mortgages Help me?
- Conclusion
The Role of the Bank of Canada
The Bank of Canada is our country’s central bank, and its role, as defined on its website, is to “promote the economic and financial welfare of Canada.” They do this through a variety of methods; the main one we’re going to look at today is their monetary policy. This is a term that you may or may not have heard or understood in the past. Basically, the Monetary Policy that the Bank of Canada applies makes use of tools like interest rates to influence the supply of money in the economy and, as such, control inflation.
What does the Bank of Canada do? You can’t walk into the Bank of Canada and open a chequing account. One of the things they do as the central bank is they set the interest rate that applies to loans between financial institutions. It’s easy to see the correlation between this and how it affects you as a consumer. If the Bank of Canada decides to apply higher interest rates to the loans between financial institutions, they pass their increased costs on to consumers. This happens because the same financial institutions that have to pay more to borrow money will now end up charging you, the customer, a higher interest rate on loans and mortgages. The next time a big bank decides to absorb an interest rate increase and not pass on their increased costs to their customers, it will probably be the first time one has ever done this.
The monetary policy controls the amount of money circulating by controlling the cost of borrowing. When interest rates are high, consumers have a harder time securing the ability to borrow for larger purchases. This reduces the amount of money circulating in the economy and, in turn, reduces the inflation of prices. Higher interest rates are meant to increase the incentive for people to save and decrease the incentive to spend. When this happens, inflation decreases. Conversely, making interest rates lower and money easier to obtain and spend can increase inflation because the demand for something exceeds the supply. So when inflation rates went up due to a variety of issues (supply chain, COVID, low interest rates, etc.), the Bank of Canada quickly increased rates to attempt to bring the rate back into line with its target. Now that they have achieved this, we should see a period of rates being lowered to the point where they stabilize inflation, no longer looking to decrease it.
Why Do I Care About Monetary Policy?
As a consumer, there are two ways that interest rates can affect you.
The first one is that it can encourage you to save money. In March of 2022, when interest rates were 0.25%, there wasn’t a lot of incentive to save in an interest-paying account because the return was so low. In fact, the rate was so low that the increase in the prices of things due to inflation exceeded what you were earning in interest, so in reality, you were losing purchasing power if you saved in an interest-earning account. As rates increase and you can earn more money in interest, the incentive to save grows as well. And the money that you are saving is not out there being used to buy things, helping to stem inflationary pressure on prices.
The second way it affects you, and the one most people are interested in is that it changes what it costs you to borrow money. This applies to loans, credit lines and mortgages but in different ways.
With loans and lines of credit as interest rates go up you are less likely to utilize these products to make major purchases. The cost of borrowing the money exceeds the value you perceive from whatever you want to buy, so you don’t do it. Again here, not buying things helps decrease inflation.
Mortgages are a bit different because they come in different forms. Variable-rate or fixed-rate mortgages.
- Variable rate mortgages are tied to what a lender charges as its ‘prime interest rate.’ This rate is linked to the Bank of Canada interest rate, so when the rate goes up or down, your mortgage payment will go the same way. The latest cut should lead to a decrease in prime rates and people with variable rate mortgages getting relief from a cycle where they faced rapidly increasing payments as rates rose so rapidly.
- Fixed-rate mortgages are different because when you sign on for the term, you know in advance what the interest rate that you are going to pay is for the duration of the term. This means that a decrease today won’t change what you are paying right away. These mortgages renew at the end of their term, and this is where the rates are important. As interest rates decrease, we expect to see the interest on fixed-rate mortgages decrease as well. In reality, if you’re in a five-year fixed mortgage and it is coming up for renewal, you are going to be paying higher interest than you were. This is simply due to the fact that the rates five years ago were very low.
How can Working with Strata Mortgages Help me?
If you are on a fixed-rate mortgage and you are approaching the end of the term, working with Strata Mortgages can help you in a variety of ways. The first is guiding you through the decision of whether a variable or fixed-rate mortgage is the right choice for you. The mortgage agents at Strata take the time to get to know about you and your personal financial situation. Can you handle the potential fluctuations in payments financially? How about emotionally? Even with the long-term potential of saving money in a variable-rate mortgage, some people simply prefer the ease of budgeting for the same fixed amount every month. If your agent doesn’t take the time to understand you and how you feel about this, they aren’t providing you with the best solution possible.
Another way that the against at Strata Mortgages can help is devising a strategy for you regarding the potential for further rate decreases in the near future. The June 2024 reduction is the first in what is expected to be a longer series of decreases. The Bank of Canada has indicated that with inflation being reduced to within its target range, it expects to see more rate reductions. If your mortgage is up for renewal right now, you need to have a strategy that works for you if you are choosing fixed-rate products. Strata Mortgage agents can help with things like finding potentially shorter-term mortgages that would allow you to take advantage of lower interest rates in the next few years as opposed to locking you into a longer-term plan. Again, you need a mortgage agent who will take the time to understand your personal situation and find the right solution for you.
Conclusion
There has been a lot of pain and uncertainty in the short term while monetary policy was used to combat inflation. Now that it is showing signs of cooling off, we will see an easing in the interest rates that we pay on borrowed money in Canada. How long it will take to see rates decline is a guess right now, as the Bank of Canada doesn’t want to move too quickly and then have to backtrack because inflation ramps back up because they jumped the gun on reducing rates. What you should know is that no one expects rates to go back down to where they were when the global pandemic was in full swing. Those were historic times for many reasons, and that interest rate was one of them, so if you’re waiting to see those rates again, you may be waiting a long time.
If you are a homeowner with a mortgage that is renewing you owe it to yourself to take the chance to talk to a mortgage agent who doesn’t work for a bank. The team at Strata Mortgages will take the time to understand your personal situation and then shop their extensive network of lenders to make sure that you land the right solution for your situation.
