Intelligent Investment

Higher Interest Rates To Slow Growth

Canada Monthly Mortgage Commentary

28 Jul 2022 2 Minute Read

The Bank of Canada’s surprise move to raise interest rates by 100 bps earlier this month highlighted the central bank’s focus and urgency to cool inflation. With inflation rising to decades-high levels and more importantly, as signs emerge that inflation expectations are becoming more entrenched in Canada, the central bank has once again accelerated its pace of monetary policy tightening. In the Bank of Canada’s Q2 2022 surveys of executives and consumers, it found that inflation expectations for the next two years reached record highs. In order to prevent further entrenchment, the central bank is now front-loading their interest rate hikes to quickly reach the terminal rate that it expects to finally bring inflation down.

This rate is expected to be as high as 3.50% and falls under what is considered to be restrictive territory for an economy. As a result, this means the Bank of Canada is committed to stifling inflation even if it comes at the expense of economic growth. The rationale is that the economic cost of restoring price stability from runaway inflation would be even higher.

Most banks and economic advisory firms are not forecasting a recession in Canada as their baseline scenario, but growth projections for H2 2022 through to 2024 have been significantly lowered. RBC Economics is the exception and is calling for a recession to occur in the middle of 2023, albeit a mild and short one. Consensus holds that while downside risks remain elevated, the Canadian economy entered the second half of 2022 on strong footing and should be well-positioned to adapt to a tighter monetary policy environment.

Given the uncertain economic outlook and material increases in the cost of debt, commercial real estate investment activity slowed in Q2 2022 as firms retreated to a more cautious approach. Cap rates rose across nearly all sectors and geographies during the quarter with further interest rate hikes expected to see cap rates trend upwards. While top tier assets continue to garner interest, overall activity is expected to remain muted until later in the year. Interest in Canada will persist over the long term and volumes are expected to ramp up once there is better visibility into pricing changes.

Economic Highlights:

  • Employment fell by 43,200 jobs in June 2022 and a shrinking labour force brought the unemployment rate to a new record low of 4.9%.
  • Inflation rose to 8.1% in June 2022, its highest level since 1983.
  • Retail sales rose by 2.2% in May 2022 with preliminary expectations for a further 0.3% increase in June.

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