Higher interest rates are looming increasingly large. When they come, Canada’s highly leveraged households are sure to feel the effects, says a new report from CIBC World Markets Inc.’s deputy chief economist, Benjamin Tal.
In the wake of the Bank of Canada’s most recent rate-setting and monetary policy report, markets have turned increasingly hawkish on rates, the report said.
Currently, markets are pricing in six rate hikes next year, possibly starting as soon as March, with a seventh hike in 2023, the report said.
CIBC’s own forecast is for the central bank to be somewhat more cautious than that, with rate hikes spread across the next couple of years. “But clearly, we have reached a point in which we have to assess the impact of any potential Bank tightening,” the report said.
The biggest concern is households that have amassed ever-higher debt loads during the pandemic. The report noted that household debt levels rose by almost 10% during the pandemic to more than $2.53 trillion, representing 173% of disposable income.
“Elevated and rapidly rising household debt levels mean increased sensitivity to higher interest rates,” the report said.
Approximately 70% of that debt pile represents mortgage debt, and 25% of that is variable rate.
The report noted that the structure of the mortgage market will insulate households from some of the effects of a tightening cycle.
For instance, it said that borrowers who originated their mortgages in the years before the onset of the pandemic (2017 through 2019) “will not be exposed to the full impact of potential rate hikes in the coming years.”
Still, higher rates will crimp housing demand and may curb consumer spending by households with variable-rate mortgages. Lines of credit will be impacted too. “Furthermore, if rates stay elevated into 2025, the massive borrowing undertaken during the pandemic will feel the full bite of higher rates,” CIBC said.
“Despite the protection enjoyed by existing mortgage holders, higher rates will still be effective in slowing economic activity,” the report concluded. “Moving too fast (as the market suggests now) is therefore inadvisable.”