The cost of borrowing continues to rise in Canada, placing additional strain on the finances of individuals and businesses.
On Jan. 25, the Bank of Canada increased its overnight policy rate to 4.5 percent and said it will continue its policy of “quantitative tightening” in an attempt to cool domestic inflation rates and keep a lid on the country’s supercharged economy.
The BoC policy rate, which has a direct influence on interest rates for loans and mortgages offered by banks, credit unions and other commercial lenders, is now at its highest level since April 2001.
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Canada’s inflation rate dropped to 6.3 percent in December. That’s down from 8.1 percent in June 2022, but well above the Bank of Canada’s target inflation rate of two percent.
“Global inflation remains high and broad-based,” the BoC said in a news release issued Jan. 25. “Inflation is coming down in many countries, largely reflecting lower energy prices as well as improvements in global supply chains,” it added.
“Despite this progress, Canadians are still feeling the hardship of high inflation in their essential household expenses, with persistent price increases for food and shelter.”
Canada’s economy has been running at a fevered pace for the past year or more.
Economists say the COVID-19 pandemic, which impacted consumer spending patterns and disrupted global supply chains, resulted in heightened global demand for consumer goods as well as limited supplies of everything from cough syrup and cucumbers to car parts and combines.
Government stimulus packages contributed to the economic upset, injecting hundreds of billions of dollars into the Canadian economy through COVID relief programs such as the Canada Emergency Wage Subsidy and the Canada Emergency Response Benefit (CERB).
In response to the pandemic, Ottawa delivered in 2020 alone an estimated $118 billion worth of relief to private businesses and non-profit corporations and another $105 billion to individuals, according to an investigation of public accounts conducted by the CBC.
Spending on CERB was estimated at $81 billion in 2020.
These factors and others resulted in an overheated Canadian economy, characterized by rapid spending in an environment of restricted supplies and rising prices.
“In Canada, recent economic growth has been stronger than expected and the economy remains in excess demand,” Canada’s central bank said.
“However, there is growing evidence that restrictive (Bank of Canada) monetary policy is slowing activity, especially household spending. Consumption growth has moderated from the first half of 2022 and housing market activity has declined substantially.”
As the effects of interest rate increases work through the economy, spending on consumer services and business investment is expected to slow, the BoC added.
Weaker foreign demand is also likely to weigh on exports.
Canada’s economy grew by an estimated 3.6 percent in 2022.
The country’s gross domestic product is expected grow by about one percent in 2023 and about two percent in 2024, the BoC said.
Inflation is projected to come down significantly in 2023, based on expectations of lower energy prices, improvements in global supply conditions, and the effects of higher interest rates.
The Bank of Canada sees Canadian inflation falling to around three percent by the middle of 2023 and two percent in 2024.
For debt-carrying Canadians, the promise of lower inflation rates comes as welcome news. But the impact of rising interest rates could have equally damaging financial consequences.
Canada’s household debt, which includes mortgages and other consumer debt such as loans and outstanding credit card balances, rose to a record $2.8 trillion in late 2022.
The average Canadian household is now spending nearly 14 percent of its income to service outstanding debts.
In a press conference, Bank of Canada governor Tiff Macklem said there are signs that the series of rate hikes announced since early 2022 are working to bring Canadian inflation under control.
Over the past 12 months, the bank has increased its overnight lending rate eight times.
The industry leading benchmark now sits at 4.5 percent, up from just 0.25 percent a year ago.
But Macklem also acknowledged the Canadian economy hasn’t yet cooled as much as expected.
“Recent data suggest the restrictive stance of monetary policy is dampening household spending, particularly on housing and big-ticket items,” he said. “But economic growth and employment in the second half of 2022 were stronger than we expected.”
Excess demand in the economy has persisted, putting continued upward pressure on prices, he added.
“Simply put, our overheated economy did not cool as much as we expected. We know it takes time for higher interest rates to work through the economy to slow demand and reduce inflation. And given the speed and magnitude of the interest rate increases over the last year, their full effect is still to come.”
Macklem said the Bank of Canada now expects to pause rate hikes and assess their impact.
“To be clear, this is a conditional pause. It is conditional on economic developments evolving broadly in line with our (monetary policy report) outlook. If we need to do more to get inflation to the percent target, we will,” he said.
For the Canadian agriculture industry, financial risk stemming from higher commercial interest rates continues to increase.
For highly leveraged producers on the Prairies, the impact of higher debt servicing costs could be huge, particularly if farm revenues are negatively impacted by drought or major fluctuations in commodity markets.
According to the most recent figures from Statistics Canada, total farm debt in Canada rose to nearly $130 billion in late 2021, an increase of nearly 40 percent over the previous five years.
JP Gervais, chief economist at Farm Credit Canada, said borrowers in the Canadian ag sector can expect interest rates to hold steady throughout most of 2023, barring drastic changes in the economic outlook.
“The Bank has made it very clear that it expects this to be the last increase of the cycle of interest rate hikes that started in Q1 of 2022,” Gervais said in a Jan. 26 email to the Western Producer.
“Unless the economic outlook changes drastically, we expect that we’ve seen the last increase from the Bank of Canada.”
Gervais said Bank of Canada statements suggesting a pause in interest rate changes should bring clarity to farmers who are looking to make decisions on loan portfolios.
Growers should not expect the central bank to lower its overnight rate, even if there’s an economic slowdown in the first six months of the year, he added.
“Short-term rates should stay where they currently are for most of 2023,” Gervais said.
“Long-term rates – for example a five-year fixed rate – have come down in recent months and are expected to stay at the level they’re at for the foreseeable future.”
