Posthaste: Why Canada may need deeper interest rate cuts than other major economies – Financial Post

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There was a sense the tide had turned when Swiss National Bank surprised markets and cut its interest rate on Thursday — the first of the central banks in the developed world to do so.

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It put a big question out there — who’s next?

The stage is being set for other central banks to follow the Swiss, says Avery Shenfeld, chief economist of CIBC Capital Markets — but when isn’t the only question — it’s also by how much.

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“Once inflation looks sufficiently tamed, the dosage will come down to just how much of an economic squeeze the existing level of rates has applied,” he said in his weekly note Friday.

Canadians, he argues, could use a bigger dose of rate relief than most in the world.

Higher interest rates have clearly had a big impact on Canadians, especially in comparison to their neighbours to the south. Canada’s per capita consumption is falling, but American consumers, up until recently, have kept up their spending, helping the U.S. economy avoid the slowdowns seen here, and in the United Kingdom and much of Europe, said Shenfeld.

How mortgages work in different countries has a lot to do with that impact. Americans largely have 30-year mortgages, while mortgages in Canada, the U.K. and Australia reset about every five years. Germans often lock in for 10 years or more, but the U.S. is the only place where a 30-year fixed rate is the norm, he said.

But even compared to countries who share shorter mortgage terms, Canadians are worse off. The ratio of home prices to incomes in Canada has risen 40 per cent since 2015, according to Organisation for Economic Co-operation and Development data, “far eclipsing what’s been seen in other countries where mortgage borrowers are also exposed to rising rates,” said Shenfeld. Countries with older populations like Japan and some EU nations also have fewer outstanding mortgages.

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As CIBC’s chart shows Canadians are second only to Australians among seven major economies in the share of their income spent on interest and principal, thanks to the sharp increase in home prices and a collective rise in debt service costs.

“Put it all together, and Canada’s household sector was set up to be among the most vulnerable to rising mortgage rates,” Shenfeld said.

As a result, Canada could need bigger interest rate cuts to get the economy moving again. That is reinforced, he said, by the fact that about half of all mortgages still face renewal under considerably higher rates. Those coming due in 2025 will be facing an adjustment up from when rates were near zero in 2020.

“Whether Canada will be next after the Swiss, or wait a bit longer, there’s a good reason to expect that rate cuts will have to be deeper here than in countries with lower household debt burdens, cheaper houses, or locked-in mortgages,” said Shenfeld.

How deep then is the question, and to that there may be no easy answer. Much will depend on whether data to come shows the economy holding its own or tanking.

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Most economists expect the Bank of Canada to start cutting its interest rate in June, but predictions on by how much vary.

Economists at Bank of Montreal and the Royal Bank of Canada expect 100 basis points of cuts this year and 100 the next, bringing the interest rate to 3 per cent by the end of 2025.

CIBC is forecasting a slightly deeper reduction, with the central bank cutting the rate by 25 bps in June, followed by a 50 bps cut in September and another 50 in December, to end the year at 3.75 per cent. By the end of 2025, they forecast the overnight rate will be down to 2.75 per cent.

Toronto Dominion Bank’s forecast goes even further, predicting interest rates will be cut to 2.25 per cent by the end of 2025.

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Looking back 40 years, Canadians can take some comfort that this isn’t the worst housing affordability crisis the country has been through.

Today’s chart from BMO Economics senior economist Sal Guatieri shows that the “first and worst” hit in 1981, when mortgage rates were at 21 per cent and payments and utilities ate up 65 per cent of disposable income. Nine years later in a “speculative bubble,” mortgage rates were at 14 per cent, taking up 55 per cent of income. And that brings us to today.

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Guatieri says affordability probably improved somewhat early this year as mortgage rates eased and home prices fell further, “but buyers shouldn’t expect meaningful relief until the BoC brings down policy rates.”

Today’s Data: U.S. new home sales

The contribution limit for your tax-free savings account this year is $7,000, meaning you have as much as $95,000 in room if you’ve never contributed before. But some taxpayers still exceed their limits and then claim they didn’t know the rules when the taxman comes calling. Tax expert Jamie Golombek says that’s a defence that won’t win. Find out more

Are you worried about having enough for retirement? Do you need to adjust your portfolio? Are you wondering how to make ends meet? Drop us a line at aholloway@postmedia.com with your contact info and the general gist of your problem and we’ll try to find some experts to help you out while writing a Family Finance story about it (we’ll keep your name out of it, of course). If you have a simpler question, the crack team at FP Answers led by Julie Cazzin or one of our columnists can give it a shot.

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McLister on Mortgages

Want to learn more about mortgages? Mortgage strategist Robert McLister’s Financial Post column can help navigate the complex sector, from the latest trends to financing opportunities you won’t want to miss. Read them here 

Today’s Posthaste was written by Pamela Heaven with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.

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