Why Bank of Canada is in no rush to cut interest rates

Governor Macklem says world is in transitional period

Why Bank of Canada is in no rush to cut interest rates

Although higher rates raise consumer debt and risk weakening the stability of the Canadian financial system, Bank of Canada governor Tiff Macklem has no intention of rushing to reduce rates.

At a press conference on Thursday to announce the central bank's most recent financial sector examination, Macklem said: ``Nobody should expect that interest rates are going to go back down to the very low levels that we've seen over the last decade or so.''

The central bank expressed greater worry than it did a year ago about the risks presented by that debt in its annual financial system assessment, which also underlined its worries about Canadian consumers' capacity to manage their debt during that transition.

``We're in a transition period to a world where interest rates are going to be higher than what many people have gotten used to and that transition is going to take a while. And through that transition, that creates some risks.''

Mortgage payments have increased as a result of the Bank of Canada's recent rate-hike campaign, with fixed payments on variable-rate mortgages and 20–25% higher payments on fixed-rate mortgages compared to 2022 levels. As a result of taking out big mortgages with protracted amortization terms, many Canadians now have less financial freedom.

For fixed-rate mortgages with fixed payments and variable-rate mortgages with fixed payments, this has resulted in payment increases of up to 40% and 25%, respectively.

``A longer amortization period reduces the size of monthly payments, helping lower debt-servicing costs, but increases the period of household vulnerability because equity is built more slowly,'' the bank stated.

More loan defaults may result from a catastrophic global recession that significantly lowers house values, the report said. Due to the significant proportion of uninsured mortgages that Canadian banks maintain on their balance sheets, huge credit losses might arise in the event of widespread defaults.

According to Carolyn Rogers, senior deputy governor of the bank, Canadians have a long record of repaying their obligations while being under hardship, and so far, households are showing tenacity despite the major rise in interest rates.

``However, in a severe and prolonged recession, mortgage defaults could rise, leading to credit losses for lenders. That in turn could lead to a further pullback in credit, worsening a downturn,'' Rogers said.

The recent financial crises in the United States and Switzerland have shown further vulnerabilities in the present climate of increased interest rates, according to the Bank of Canada. The deposit runs at Silicon Valley Bank and Signature Bank in the United States earlier this year shown how fast conditions may deteriorate.

The Bank of Canada has issued a warning that Canadian institutions may tighten their lending requirements if the cost of wholesale borrowing for Canada's big banks were to dramatically increase because of financial crisis on the international stage. Macklem stated that if indications suggested that inflation was expected to remain over its two percent objective, the central bank would be willing to hike rates further.

Prior to its next monetary policy decision on June 7, the central bank anticipates the cost of living to remain on a general downward track, notwithstanding Statistics Canada's announcement that inflation increased in April for the first time since last June.

According to the Bank of Canada's annual report, financial stress is increasing among small enterprises, with half of those that obtained government assistance during the pandemic stating that it would be difficult to repay the grants by the end of this year. The central bank is keeping an eye on the development of cryptoassets and how they relate to the financial system, but because such markets are still rather tiny, there is no systemic risk currently.

“We're determined to get inflation all the way back to the two per cent target. Inflation is coming down, we expect it will continue to come down,” Macklem said. “We'll be looking at all the data we've received over the last six or seven weeks and we'll announce our decision.”