Last month, the Bank of Canada announced its first rate hike of 2018 with more increases expected to come later this year. But, according to a pair of economists at one of Canada’s largest banks, interest rate increases that are likely in the pipeline won’t make a severe dent in Canadians’ wallets.
“As a direct result of the expected increase in interest rates, Canadians will pay in aggregate roughly $3 bn more for debt service in the coming year, something that by itself would have contributed to only a minor slowdown in spending,” write CIBC economists Benjamin Tal and Royce Mendes in a report published late last week.
According to the economists, it will take more than higher interest rates to “break consumers’ backs.” However, higher rates combined with a pullback in job creation and new mortgage regulations will cause a noticeable slowdown in household spending this year.
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“Fortunately, for the economy as a whole, the deceleration will feel more like a gearing down rather than slamming on the brakes,” write Tal and Mendes.
Although Canada’s debt-to-income ratio now sits at a record 171 per cent, 2017 was a booming year for the Canadian economy with increased household consumption, employment gains and heightened consumer confidence.
But, the economists are quick to note that a tighter labour market is slated to cool the pace of job creation in 2018, resulting in less room for further consumption growth.
The question remains — how much will higher interest rates directly impact Canadian households?
“Indeed, we’ve shown before that debt loads have made interest rate hikes almost 50% more potent relative to the early 2000s. But that doesn’t mean we jumped on the alarmist bandwagon…,” write Tal and Mendes.
According to the economists, one-third of Canadian households are debt-free. Of those with debt, two-thirds have non-mortgage credit and the remaining have both mortgage and non-mortgage debt. The report notes that the share of those with only mortgage debt is negligible.
Tal and Mendes argue that the sensitivity to Bank of Canada rate hikes can vary widely for all credit products. For mortgages, the pair say that the majority of non-fixed rate debt is variable where payments don’t change but the amortization does.
In total, for both mortgage and non-mortgage debt, Tal and Mendes estimate that less than 20 per cent of the outstanding household debt has been exposed to higher rates so far.
“Looking ahead, assuming the Canadian yield curve shifts higher by 50 bps, that number rises to roughly 30 per cent,” reads the report.
Tal and Mendes caution that going forward, higher rates will have a bigger impact on consumers as debts will reset in coming years.