Inflation. There. I said it. But what does it mean for rates...?

The Forgotten Boogeyman

Well, inflation, it's been a minute. 

If you're like me, the concept of inflation was something to be learned about in course textbooks or an ages old campfire story previous home-buying generations tried to spook us with. Those stories typically started with something to effect of: "When I bought my first house, interest rates were 97% and a house only cost a nickel!!!" Heck. When I first started as a Mortgage Broker back in (gasps) 2007, the first mortgage commitments I put out were for just shy of 6% fixed mortgage rates. But the times, they have a-changed. 

What follows is my best effort to simplify a lot of the Economics reading out there into something that's a little easier to read and hopefully (crosses fingers) provides some good insight into what's happening, why, and where we're likely to go. But, if you don't care for Economics, I can save you some reading with a short summary: Don't worry. It's all going to be okay. Don't jump on the fear-bandwagon and lose sleep over the inflation monster that is waiting under your bed for that moment your foot escapes the covers for a blast of cool air. That monster is a shadow of its former self. Slow. Out of shape. Kinda sleepy. You can take it down. And so can Uncle Tiff Macklem of the Bank of Canada (he's not really my Uncle. Probably.)

Now, if you're still with me after two paragraphs, inflation is a real thing and it's something we're experiencing right now. But most believe it to be a temporary surge for a handful of different reasons:

• Broken Supply Chains: the pandemic did a lot of things. Changed buying patterns. Shut businesses down. Affected transportation of goods and services. Hurt developing world economies. Lumber mills closed up or went to skeleton crews and ran down their supply. Computer chips became harder to come by. Anyone who's tried to build a deck or buy a PlayStation or a new model car feel that pain.
• Price sensitivity has been lower. Consumers have wants and have been willing to pay more to get those wants. Pandemic fatigue is a real thing. Remember when you couldn't get a hair cut? How much more would you have paid to get those locks trimmed when things opened back up?
• Economies are easing up on pandemic restrictions. Many service sector jobs were hit hard by the pandemic. As restrictions ease, demand has increased in these sectors that triggers wage growth and spending increases.
• We're measuring against numbers that were depressed as a result of the pandemic and lock downs. A certain something hit the fan last year. The Central Bank and Federal Government did everything they could to help out Canadians but there was a degree of damage done to spending and prices. Today's numbers are being measured against depressed prices which will somewhat exaggerate the effect of inflation. In this case, inflation is actually a sign of success!

The Bank of Canada (BoC) has taken the stance that this surge in inflation is temporary and will ease as damaged supply chains are repaired and the flow of goods rises to meet demand and restrictions continue to ease around the world and we see a return to our normal patterns. And with that thinking, the BoC are prepared to tolerate the higher inflation for the moment and leave interest rates alone for fear that increasing them would have a negative impact and stall our recovery.

But Ray, rates can only go up from here, right? Yes. That is the case and that's not a bad thing. Long term, the Bank of Canada is still targeting a 2% inflation rate (the mid-point in their 1% to 3% tolerance range). And they have the tools to manage that. Just as they had the tools to prevent disinflation when the lockdowns started (and probably deserve a round of applause for that). As of today, they are targeting a late 2022 increase to the Overnight Rate. But here's the good news: that rate increase will be powerful. Roughly twice as powerful than it was 10 years ago according to CIBC Economist Ben Tal. And so, my expectation, among others, is that the overnight rate will rise more slowly than it would have in the past.

Think about this: since 2008, interest rates have been low. Like really low. Effectively all of the debt out there in Canada is and has been at these low rates. So when rates start to increase, the slowing -down-effect will be more pronounced. A borrower who's accustomed to 2% rates will see a 0.25% increase as significant. And that's not a bad thing. It most likely means those increases will be spaced out and move more slowly. So when those rates do start to rise, fight that urge to panic! It will all be okay! You were stress tested for this. We knew this was coming. Don't buy into the hype and fear.

Are we out of the woods? Certainly not. COVID variants pose a larger risk to developing countries with low vaccination rates. The recovery globally will be uneven. But we have the tools and the patience to see this through. We will get there and I promise, it will all be okay! 

If you'd like to talk about your situation or found this useful, get in touch with me and pass it on to a friend! We're always here to help.