At some point, you possibly visited the grocery store and realized that a kilo of chicken that was sold for, say, $7 the week before, now goes for $7.50. And then you go back the following week and the new price is $7.80. Well, sometimes the timeframe isn’t that small, and this isn't just with chicken. In a broader sense, it happens with most, if not all, categories of goods and services.
If this sounds familiar, then you have just seen one of the effects of what is called "inflation" in economics.
Inflation refers to the general increase in the prices of goods and services over time. When this phenomenon is left unchecked, it can cause an economic recession. This general increase in prices only really becomes a problem when wages do not increase well enough to match them. It does not also mean that inflation is all bad. Economists say that a certain level of inflation is good for the economy. To them, an annual inflation rate of about 2% is an indicator of a good economy. In the same vein, the Bank of Canada has the mandate to keep inflation at that rate (2%).
Since inflation affects just about everything, even interest rates are not left out, as well as mortgage rates. When it comes to mortgage loans, the interest rates depend on some factors. Some of these factors you may have under control. The other ones aren’t. Oftentimes, the factors that are beyond your reach have to do with the performance of the economy. A very good example is inflation.
Typically, inflation leads to higher mortgage interest rates because it devalues the Canadian Dollar. According to Amy Shunick of Bennett Packaging, "While inflation doesn't directly affect mortgage rates, it can indirectly cause mortgage rates to increase."
Inflation also reduces investor demand for mortgage-backed securities. When demand decreases, the price of mortgage-backed securities falls. This means higher interest rates for all mortgages. Therefore, mortgage interest rates rise during periods of high inflation. This means that a higher interest rate means more monthly payments, which makes getting a mortgage more expensive.
While no one can predict exactly what mortgage rates will be like in 2022, it is likely that they will continue to rise, largely due to inflation. In addition to inflation, geopolitical events such as the Russia/ Ukraine seems to be causing economic problems such as high energy prices, which can lead to supply shocks and inflationary pressures in the economy.
"Rising inflation not only shrinks people's purchasing power but also affects the cost of borrowing," says Vicky Noufal, owner and associate broker with Platinum Group Real Estate. "If the inflation rate rises, the interest rate will also follow the same trend. As a result, home buyers have to pay more for a mortgage. Anyone looking to get a new mortgage will have to pay higher monthly mortgage payments. So, inflation has a critical effect on the mortgage interest rate."
In as much as it seems that inflation could seem out of control, the Bank of Canada sometimes employs certain techniques to curb it. However, it doesn’t work all the time or better still, the effect takes a little while to show. For instance, the Bank of Canada raises interest rates significantly. What this means is loans become discouraging, and overall spending reduces. This age-long technique has been proven to help reduce inflation.