This article is written by SPS Member Rebecca Awram, a mortgage advisor for Canadian Mortgage Experts, sharing her opinion from a mortgage perspective.
So many questions coming in from my clients on this topic. Everyone's looking for a simple answer, but it's a complicated question that requires a detailed response. I understand you're all looking for reassurance, but to truly receive comfort, you need to understand what's going on. So brace yourself, there's a lot to unpack here. Read it twice :)
Prime rate is increasing, currently sitting at 3.70%. Pre-covid in late 2019 it was at 3.95%. So nothing too crazy yet. What is crazy, is our rate of inflation. We haven't seen inflation like this since the 70s and 80s, and the concern of many of my clients is that like the 80s, this inflation will lead to a housing crash. The Canadian government was probably a bit too slow in reacting, and now is faced with the difficult task of slowing it down, even if it means putting us in a recession to do so. They have been criticized for not reacting fast enough, created a credibility issue, and hence will probably over react in the short term. Our government, unlike the governments of the 70s, are inflation fighters. They will ultimately do whatever it takes to get us back to target-inflation, with the mindset that the cure is not as bad as the disease. The economy needs to be slowed-down. But killing inflation also kills the economy
What is Causing Inflation? Are We Back To The 70s?
The 70s saw soviet tanks, war, energy shocks, opec pricing power and a massive spending frenzy of a rising middle class. An era of unprecedented technological growth and people that wanted vehicles, appliances and homes to put them in. Nobody was saving, everybody was spending and interest rates went through the roof.
Some of these items should sound familiar. But there are some stark differences. Our spending frenzy is winding down, as people stop buying the goods they wanted in boredom during covid (entertainment, projects, renovations, new hobbies, etc). Our employment rate is very high. We haven't stopped saving either, Canadians currently have $300B more in their bank accounts than we did pre-covid. Prices are continuing to rise, but it's not necessarily because of demand, it's because of constrained SUPPLY. There is an energy crisis evolving, a shortage of access to fuel, as countries around the world pull away from Russian oil. The war itself is pushing upwards on commodity prices. China has pretty much been closed for business all year, with a strict no-covid lockdown policy so their cheap goods and anything that needs a chip aren't making it to global markets. Supply chains around the world have been disrupted and are just starting to amend. All of these things lead to higher prices. Also people and businesses, sensing scarcity, compete to purchase more and hence drive up pricing even further. The system feeds on itself.
Will Increasing Rates Stop Inflation?
Probably not. Because low rates (demand) aren't what's driving it up. It's a supply-side driven inflation. But rising rates and a frightened populace that stops buying and spending, could afford us the time we need for some (not all) of these things to sort themselves out by winter 2022/23.
1. ENERGY SHOCK - always brings inflation. However, this time around, our dependency on oil is lower than it was during the 70s. Because of climate change, but also because of efficiency and usage. We are close to peak inflation, in relation to energy.
2. SUPPLY CHAIN - that's about 60% of inflationary pressures right now. The year 2021 had four years of average-consumption-of-goods crammed into one year. Demand shock with diminished supply. All related to covid, which about a year from now, should be irrelevant. Taking interest rates to the sky won't solve supply chain disruptions.
3. RENT - will continue to rise. It didn't go up as quickly as house prices during the pandemic, but during covid homebuyers got the benefit of a recession without the downside, renters did not. This has never happened before. Rent will continue to rise because of huge demand and lack of supply.
4. LABOUR MARKET - we simply cannot get enough people; wages are rising in low paid occupations, especially among job switchers. New immigrants traditionally took up a lot of the low paying jobs, but we now have highly skilled and more educated immigrants, so there's been a significant change in the structure. Young adults also traditionally fill a lot of low wage / labour positions, but during covid remote-work created more options and a huge chunk have moved to higher paying occupations.
Will Our Housing Market Crash?
The housing market is slowing. THIS IS A GOOD THING. It is a welcome adjustment, we shot way too high in late 2021 and early 2022 and a course correction is needed. Everyone benefits in a balanced market, instead of just one side over another. And it will continue to soften during 2022 because the government is raising rates and frantically trying to slow us all down, so that some of the things that are REALLY causing inflation (mentioned above) have time to correct. The long term trajectory for our market is still high, because the fundamentals remain the same. Immigrants, and demand, are ever-present. Supply is not. Cost of construction is rising (because of inflation on hard costs, but more importantly also the cost of labour) and developers are seeing their margins shrink. Many lower mainland projects are getting shelved right now, as developers want more certainty in expense and would rather start these projects when the inflationary pressures have subsided and costs are more predictable. So when we do wake back up and demand returns, supply will be even lower. Study after study says we have an existing supply problem against a backdrop of an increasing population.
Defaults, foreclosures and a housing crash? People rarely lose their homes because of rising rates, they lose their homes because of death, divorce and job loss. The metric you want to watch, if you're concerned about a housing crash, is unemployment. And that is at an all time low. Not a recent low, an ALL TIME RECORD low.
Additionally, people aren't as over-extended as the media would have you believe from their click-bait headlines. All those low rate mortgages taken out during covid had to qualify at 5.25%. And average mortgage sizes did not increase at the same increment as housing prices. What increased at the same pace was down payments. First time buyers were largely sidelined, but existing homebuyers moved up and moved out to secondary properties, with big fat down payments from their sale or refinance.
When Will Rates Stop Going UP?
It is much easier to predict long term outcomes than short term ones. 2022 is definitely a transition year, as we move from a pandemic to an endemic. Things will evolve. The effectiveness of monetary policy remains to be seen, but eventually the war will end, supply chains will improve, fuel costs will lower and china will open back up for business. These things do not have an end-date that we can mark on the calendar quite yet, but they will happen. And when they do, our rates will be too high to stimulate economic growth and will come back down. They won't come down to the artificially extreme low rates that we've had during covid, but I predict they will overshoot in the short term and then come down in 2023 to something that balances inflation with economic growth. It's a cycle that will play-out quite predictably, but when you're in it, it's hard to step back and see it from a distance.
Relax, turn off the news, put your phone down and go for a walk. It's all going to be okay.
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