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Bank of Canada raises rate to 4.5%

What the Bank of Canada’s latest overnight rate hike means for your finances

Bank of Canada governor Tiff Macklem raised the benchmark rate a quarter point on Jan. 25th, lifting the rate that private lenders use to set retail and commercial borrowing costs to 4.5% — a startling surge when we compare it to the 0.25% a year ago.

The rate increases have far-reaching implications for your finances, whether you’re applying for a mortgage, using a line of credit, repaying a student loan or living off retirement income.

When prime rates increase or decrease, so do variable rates. This domino effect can impact borrowers with a variable-rate mortgage, home equity line of credit (HELOC), student loan, line of credit or another type of variable-rate loan.

The Bank of Canada noted that headline inflation — as measured by year-over-year changes in Statistics Canada’s consumer price index — dropped to 6.3% in December 2022 from a peak of 8.1% in June 2022.

The Bank of Canada’s new outlook predicts that year-over-year increases in the consumer price index will average 5.4% over the first quarter, and drop to 2.6% by the end of the 2023.

That achievement won’t come without pain, some of which is already being felt by homeowners with variable-rate mortgages and anyone who relies on a vibrant real-estate market to make a living. House prices have plunged and are expected to drop further. 

Housing is probably the industry that’s most sensitive to interest rates. It led the rapid recovery from the COVID recession, when the Bank of Canada dropped the benchmark rate to almost zero and promised to keep it there for 2 years.

Now, housing is acting as a brake on unsustainably fast economic growth – 5% in 2021 and 3.6% in 2022 – that was stoking more demand than suppliers could match.

The Bank of Canada said interest payments on mortgages will be about 4.5% of disposable income at the beginning of 2023, up from 3.2% at the same point in 2022. That percentage will continue to grow as homeowners renew their mortgages at higher rates, subtracting income that otherwise could have been used to spend & invest.

What the future holds relies heavily on the stability of the Canadian economy. 

The BoC’s interest rate was slashed to historic lows when the economy needed a boost, and a gradual return to higher rates suggests the economy has recovered—and is now in overdrive.