CIBC on how the Bank of Canada should approach its rate adjustments

The effectiveness of the Bank of Canada’s interest rate strategy in the next few years lies not in the act of raising rates itself, but in how quickly the central bank will do it, according to the Canadian Imperial Bank of Commerce.

“Clearly, we have to ask the following question: to what extent are people sensitive to the risk of higher interest rates? And the short answer is now ’very sensitive’,” said Benjamin Tal, deputy chief economist at CIBC. “It’s a record high level of sensitivity. I estimate that a 1% increase in interest rates now is about 30-40% more effective than just a few years ago. So the sensitivity of households to higher interest rates has risen.”

Tal argued that a measured approach to rate hikes would ensure that homeowners are not burdened by excessive amounts of mortgage debt.

“The number one risk facing the housing market at this point is if the Bank of Canada waits, and waits, and waits, and then starts raising interest rates very quickly in a panic – let’s say in 2023 – that would be very devastating for the housing market, if you have a rapid-speed increase in interest rates,” he said in an interview with BNN Bloomberg.

“Every economic recession was helped, if not more than that, by a monetary policy error in which central bankers were raising interest rates too quickly, and you really want to avoid that,” Tal added. “We know [inflation] will be rising, we don’t know how short-lived it will be; we know that it will be rising, and if you wait and wait and wait until it’s too late, then you raise interest rates too quickly.

Adjusting the rate earlier would give the central bank more room to implement a gradual increase, which would “limit the damage” to Canadian household incomes and the mortgage market, it was suggested.

“I think that the fact the Bank of Canada is telling us that they will be moving in the second half of 2022, which is much earlier than expected just a few months ago, [is] a very positive sign,” Tal said.

MBN

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