Who has the most to fear from rising interest rates?

The Bank of Canada will release its first report of the year on Canadian monetary policy on Wednesday. Economists agree that it is only a matter of time before the institution raises its key rate, which will inevitably lead to higher interest rates in the country.

The senior portfolio manager and interim chief economist at iA Financial Group, Sébastien McMahon, expects the Bank of Canada to proceed with four successive increases of 0.25% by the end of the year for a total increase of 1%. He anticipates a similar increase in 2023.

Inevitable rise

% increase over the next two years. We got there. We won’t avoid it”,”text”:”We shouldn’t be fooled, in the next two years, interest rates will go up. We can expect there to be even a 2% increase over the next two years. We got there. We will not avoid it”}}”>We must not be fooled, in the next two years, interest rates will go on increasing. We can expect even a 2% increase over the next two years. We got there. We won’t avoid it, he said in an interview with Radio-Canada.

Sebastien McMahon expects the Bank of Canada to gradually raise its key rate by 2% by the end of 2023.

Photo: Radio-Canada

Mr. McMahon recalls that the Bank of Canada lowered the key rate to its floor level of 0.25% at the start of the pandemic in order to support economic growth.

« The idea was to make it less expensive for companies to invest so that they create jobs and that households consume. »

A quote from Sébastien McMahon, Acting Chief Economist at iA Financial Group

The measure had the desired effect, as evidenced by the strong growth in the gross domestic product Canada and the tightening labor market. There is therefore no longer any reason to maintain the key rate at its floor level, believes Sébastien McMahon.

The economy is doing very, very, very well […] We are even starting to see wage pressures arise because the economy is doing too well. So it’s really time to normalize, he insists.

A man in a tie deposits a penny in a pig-shaped piggy bank that he holds in his hand.

According to Statistics Canada, the Canadian household savings rate stood at 11% in the third quarter of 2021, compared to around 3% before the pandemic. (Archives)

Photo : iStock

Canadians who have taken out a fixed-rate mortgage will have time to see the increase coming, continues the economist. The increase in their savings since the start of the pandemic should also help them absorb the first cost increases.

That will hurt

On the other hand, among highly indebted households and those who have negotiated a variable rate mortgage, the effect of the increase is likely to be felt immediately, warns David Poliquin, chartered financial analyst (Chartered Financial Analyst), partner and portfolio manager at BGY Integrated Financial Services and iA Private Wealth Management.

As real estate has risen a lot, those who have bought recently and who have pushed the bill a little, it is sure that the monthly payment, it will come quickly and it will hurt, he predicted.

« For people who have bought large houses with variable rates, who are very indebted, when the rate goes up, it is direct, it hurts and it is on large amounts. »

A quote from David Poliquin, Chartered Financial Analyst and Portfolio Manager
David Poliquin during a videoconference interview.

David Poliquin explains that the sharp rise in inflation is particularly hurting retirees with a defined benefit pension.

Photo: Radio-Canada

David Poliquin asserts that it is not so much the rise in the key interest rate that is worrying, but what is at the origin of this rise: inflation.

As we can see, inflation has been affecting households for some time. We all do the grocery shopping. We see that the discounts are [de moins en] less discounts and that prices are higher, but that also affects the price at the pump, on that of cars, houses and rents, observes the portfolio manager.

Unheard of in 30 years

During the month of December, inflation reached 4.8% in Canada, a 30-year high. Raising the key rate aims to slow this unbridled growth.

When interest rates are higher, it costs more to borrow and invest. Demand is decreasing, which has the effect of taking pressure off supply chains. This normally contributes to slowing price growth.

« This is the big bet that central banks are making: will the increase in interest rates be enough to reduce inflation and bring it back to rates seen previously? »

A quote from David Poliquin, Chartered Financial Analyst and Portfolio Manager

He mentions that runaway inflation is hitting some Canadians harder than others. This is particularly the case for retirees with defined benefit pensions.

Unfortunately, with the level of inflation we are seeing, their pension will not keep up with the cost of living. In other words, it is a gradual impoverishment of retirees who have defined benefit plans, such as retired civil servants, emphasizes David Poliquin.

A hand holds a gas pump.

Experts predict that the cost of gasoline will average $1.80 per liter by the end of June in Quebec. (Archives)

Photo: Radio-Canada / Ivanoh Demers

In addition, their investments, often made up of a larger proportion of bonds than stocks, grow less rapidly than the consumer price index. Not to mention, notes Mr. Poliquin, that a good number of retirees have sold their property to go live in rental accommodation, which exposes them to rising rental prices.

2 or 3% like [c’est le cas pour] guaranteed investment certificates, well, it’s not keeping up with inflation right now. So their investments lose value on inflation, their rent goes up, their monthly costs go up and then their annuity loses purchasing power as well. It’s not a rosy situation”,”text”:”Even if their bond investments [avaient un rendement] of 2 or 3% as [c’est le cas pour] guaranteed investment certificates, well, it’s not keeping up with inflation right now. So their investments lose value on inflation, their rent goes up, their monthly costs go up and then their annuity loses purchasing power as well. It’s not a rosy situation”}}”>Even if their bond investments [avaient un rendement] 2 or 3% as [c’est le cas pour] guaranteed investment certificates, well, it’s not keeping up with inflation right now. So their investments lose value on inflation, their rent goes up, their monthly costs go up and then their annuity loses purchasing power as well. It’s not a rosy situation, he laments.

Prices will rise in 2022

Even if the hike in the key rate manages to reduce inflation, prices, including those of food, will continue to rise in 2022.

and7% more2022 that it cost you in2021. Inflation slows, but remains positive. So there’s not much that’s going to cost less in2022. It is the rate of price growth that should reduce”,”text”:”At the grocery store, it will cost you, according to estimates, between 5 and 7% more in 2022 than it cost you in 2021. Inflation is slowing, but it remains positive. So not much is going to cost less in 2022. It is the rate of price growth that should decrease”}}”>At the grocery store, it will cost you, according to estimates, between 5 and 7% more in 2022 than what it cost you in 2021. Inflation is slowing, but it remains positive. There is therefore not much that will cost less in 2022. It is the rate of price growth that should reduce, nuance Sébastien McMahon.

A grocery cart filled with groceries in a supermarket aisle.

In Canada, food prices are expected to increase by between 5 and 7% in 2022. (Archives)

Photo: Radio-Canada / Ivanoh Demers

He expects inflation to gradually decline by the end of 2022 until a little closer to the 2% rate recorded on average each year.

2,5, 3or 3.5%? It remains to be determined, but we should see inflation calm down simply by the waning of the impulse that we have seen recently. We already saw that in the cards, and the fact of increasing the key rate gradually this year will probably help to re-anchor it around 2% over the next few years”,”text”:”Is it going to be 2.5, 3, or 3.5%? It remains to be determined, but we should see inflation calm down simply by the waning of the impulse that we have seen recently. We already saw that in the cards, and the fact of increasing the key rate gradually this year will probably help to re-anchor it around 2% over the next few years”}}”>Is it going to be 2.5, 3 or 3.5%? It remains to be determined, but we should see inflation calm down simply by the waning of the impulse that we have seen recently. We already saw that in the cards, and the fact of increasing the key rate gradually this year will probably help to re-anchor it around 2% over the next few years., predicts the economist.

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