The Canadian economy has experienced a significant shift in monetary policy again this week as the Bank of Canada (BOC) raised its policy rate by 0.25% to 4.75% on June 7th. This move marks the largest cumulative interest rate hiking cycle since the 1980s, and there are indications that more rate hikes may be on the horizon. The current interest rates are now the highest they have been in 22 years, dating back to 2001. This week we are exploring the implications of these interest rate hikes, the reasons behind them, and their potential impact on various sectors of the economy.

The recent interest rate hike by the BOC was driven by the need to combat high inflation. The first quarter GDP numbers came in higher than expected at 3.1%, surpassing analysts' expectations of 2.5%. The economy is still growing at a faster pace than the BOC would like to see, with consumer spending increasing by 5.7% during the 1st quarter. The surprise interest rate hike aims to curb inflationary pressures and bring the economy back to a more sustainable growth trajectory.

But there are Implications for Variable Rate Holders, Renters, and Borrowers. The impact of rising interest rates is felt most acutely by variable rate holders, as their monthly payments increase. Renters also face challenges as higher interest rates can lead to increased rental costs. Businesses with existing debt or those seeking to borrow will experience higher borrowing costs, potentially affecting their investment decisions and expansion plans. Individuals looking to make purchases using credit or secure a mortgage will also face higher borrowing costs.

Residential investment has experienced a significant decline as well, with a 15% year-on-year drop and a 20% decrease relative to Q1 2022. This contraction represents the most severe decline since the 1990s. Furthermore, Canada has never witnessed a 10% annual decline in real residential investment without it being associated with a recession. Additional data from CMHC and Equifax highlights that average mortgage payments are outpacing disposable income growth by the widest margin on record. Average home equity line of credit (HELOC) payments have also increased by 50%, further straining consumers' financial capabilities.

The Toronto housing market has experienced an increase in listings, rising by 30% month-on-month. However, active inventory remains down by 23% year-on-year and is near its lowest level in a decade. Despite this, home prices in Toronto increased by a substantial 3.1% in May, marking one of the largest increases in the past decade. 

Calgary's real estate market continues to strengthen, with home sales rising by 7.5% month-on-month in May and reaching a record for that month. Although listings spiked by 30% month-on-month, active inventory is down by 40% year-on-year. Calgary's housing prices have seen a significant increase since 2020, rising from $400k to $540k, hitting a new all-time high HPI price in May.

While the current trend suggests a likely recession, it is expected to be a "normal" recession rather than a major financial crisis. The growing unaffordability of housing, increasing HELOC payments, and persistent inflation raise concerns about the ability of the average consumer to sustain spending. WE expect to see a pullback over the summer and into the balance of the year.

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