We all learn about the principles of inflation when we’re in school. You likely remember the example of having a basket of groceries. This basket costs a certain amount.
However, as the prices go up to produce what’s in that basket, the total cost of the basket goes up. In it’s very basic form, this is inflation.
I use the basket example because it’s something we’re experiencing today. In our groceries, gas, and heating, we’re all feeling the effects of inflation in our Canadian economy. But, this inflation isn’t being driven by just rising costs of raw materials or wages.
It’s being driven by poor fiscal policy and mismanaged oversight of the billions of dollars being printed and spent by the Government.
The Cause Of Our Canadian Inflation
Government generally manages the fiscal policy and the Bank of Canada manages the monetary policy.
The Bank of Canada is meant to act as a check against the government’s spending (fiscal policy). The BoC is supposed to ensure that the government’s fiscal policy aligns with maintaining the overall health of the Canadian economy. So when there’s poor fiscal policy being practiced by the government, the BoC is to mitigate the impact.
And currently, that’s not what we’re experiencing.
The primary cause of our Canadian inflation is because our country is printing money faster than the overall growth of our GDP. The Bank has put money into our economy that has no substantive product or security backing it up.
Now, you’ll see a lot of articles that say the inflation we’re experiencing right now is transitory. And, unfortunately, I have to sit on the other side of the fence with this one. Yes, there are some transitory causes, but what we are experiencing will be sustained inflation for the next few years.
But, what’s the difference? Transitory inflation is caused by blips in our production systems, such as a fire wiping out a major production facility or a weather event/pattern that changes how much farmers are able to produce, and currently war. Generally, these can be fixed or brought under control, albeit over an extended period of time.
COVID-19 should be one of those blips. And under a different government spending policy, perhaps it would have been. But, what we’re experiencing is a government that has been running deficits even before 2020, pretty much since they've taken power, usually in the +$20 billion/year.
In 2020, the government released a $325.5 billion deficit, with some estimates going as high as $346 billion. As a comparison, the federal deficit in 2019 was $40.7 billion. The pandemic was used as a means to print money faster than our economy was growing.
What this leaves us with is more permanent inflation.
A Compounding Effect
As I mentioned before, we’re already starting to see inflation in our day-to-day goods. Just about everything is costing more from food, heating, gas, soon interest on debt, etc. Since prices are going up, employees will be seeking raises in pay so they may try to keep pace with inflation in order to maintain their lifestyle.
Companies will then have to pass this increased cost onto their customers and we start to see this inflationary effect compound. In January 2022, our monthly—just monthly—inflation was 5.14%. In December 2021, it was 4.80%. That’s a significant number.
Getting Control of Canada’s Inflation - Raising Interest Rates
It’s time for the Bank of Canada to act as the check they’re supposed to be and utilize the tools available to them to stem the growth of inflation.
The BoC is going to try and take out some of the cash that’s in our economy by raising interest rates. It’s something that’s been done before and slowly over time, this will have a positive effect. What our government is saying is that inflation is going to decrease in the second half of 2022.
This isn’t going away in only six months. It takes a minimum of three months just to see the impact of rates in the economy. What should slow this inflationary pressure will be when the economy is running near capacity and stocks are replenished.
I’m all for social programs and ensuring we are taking care of those who need our help. The problem is we need a strong and vibrant economy to help pay, and more importantly, maintain these programs. Unfortunately, this government is spending huge amounts on social programs that don't generate as much revenue as they cost all the while increasing borrowing costs.
This point is significant as rates go up, the interest paid on the outstanding debt increases. The money that could have been used to support some of the Social Programs will need to be redirected towards interest payments.
Where I See Interest Rates Going
I’m willing to bet that the Bank of Canada is going to be increasing rates in the next three meetings, possibly four. Then, they are going to determine what effect that’s having on the economy before making another increase.
The money that’s been spent over the last two years has been exorbitant. I don’t think a few small rate increases are going to have the desired effect on the economy. Which is why I anticipate that we’re going to see a 5% interest rate within the next three to five years for mortgages.
Today, we’re floating around the 2.99% fixed insured, or 3.24% uninsured.
What You Need to Do If You Have a Mortgage or Are Looking for One
Ultimately, this all comes down to cash flow.
If you have a mortgage that’s coming up for maturity within the next year, you should take the time to sit down with a mortgage broker, preferably over a bank, to assess your financial situation.
For example, I’m able to put up to a 120 day rate hold on some mortgage products. If rates don’t move, it’s not an issue. But, if they go up, you’re locked in at the lower rate as long as your deal renews within 120 days.
Beyond securing a lower interest rate that will help protect you for the next three to five years, this 120 day hold also gives you time to potentially put you in a better financial position.
Example of Putting in a Rate Hold
For example, in September I had a client who wanted to secure the 1.89% rate which was available, but the penalty to break his mortgage would have been around $23,000.
He had a Home Equity Line of Credit Mortgage (HELOC) which has available credit. We both agreed that we expected the mortgage rates to increase over the next 4 months.
This point is key as one of the calculation methods to determine payout penalties is the Interest Rate Differential. As mortgage rates go up, the spread between the existing mortgage rate and the rate used to calculate the penalty shrinks, so the IRD penalty drops.
Based on this viewpoint, we implemented a plan to use the available credit in his HELOC to make the maximum prepayment on his mortgage. And as interest rates jumped, we saved $8,000 of penalty.
As he had 29 months remaining on his mortgage, he’ll be $8,000 ahead within the same timeframe as his existing mortgage. While we were going through this process it was decided to pay out his unsecured line of credit and one of the car loans. This freed up $800 a month in cash and he's got a 1.89% rate for the next five years.
If You’re Not Renewing Soon
Anything you can do today to put extra money on your mortgage over the next three to five years is going to put you in a much better position.
There are basically three ways you can achieve this.
You can take advantage of your annual prepayment privileges, change your payment schedule to accelerated bi-weekly, or increase the current amount of your mortgage payment as if you were paying a higher interest rate.
Even an additional $100/month is going to save you thousands of dollars in interest when it’s compounded over time.
I’ll end with this. Don’t let the news of rates sway you into making rushed decisions about your mortgage. You want to have a strategy that works for you over the long term and sets you up for a positive financial future.
I’m here to help you figure out exactly what that strategy looks like, so give me a call.