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House of Cards: high interest rates, more household debt, and worsening the housing crisis

The Bank of Canada is continuing its self-defeating policy of raising interest rates, and worsening Canada’s housing crisis by doing so.

A photo of the outside facade of the Bank of Canada.
The outside facade of the Bank of Canada.

Last week the Bank of Canada increased its overnight interest rate, for the ninth time in little over a year, to 4.75 per cent. In making its announcement, the Bank cited a slight increase in year-over-year headline Consumer Price Index (CPI) inflation last month. This, the Bank suggested, was one reason why it abandoned a temporary ‘hold’ on further interest rate increases announced in January.

The Bank’s rationale is ironic, because the Bank’s rapid run-up in interest rates was the main cause of that small uptick in inflation (which rose from 4.3 per cent in March to 4.4 per cent in April, on a year-over-year basis). Indeed, the official Statistics Canada announcement of the April inflation data stated this explicitly: “Higher rent prices and mortgage interest costs contributed the most to the all-items CPI increase.”

Both of those factors – rising debt service charges and rising rents – are direct consequences of higher interest rates. Mortgage debt (which constitutes three per cent of the bundle of goods and services tracked by StatsCan in its Consumer Price Index) is skyrocketing: up 29 per cent in the last year, a direct consequence of higher interest rates. Rents make up a bigger share of the CPI basket (6.57 per cent); they are also growing faster than other commodities (rising 6.1 per cent in the last year, and by much more than that in many cities).

The connection between Bank of Canada policies and mortgage debt costs is obvious. But higher rents are also a side-effect of higher interest rates. First, since fewer people can afford to buy a home, they turn to the rental market, boosting demand. Second, landlords increase rents further to cover their own (growing) debt charges – and the housing shortage allows them to lift rents with impunity.

READ MORE: Inflation is coming down – but interest rates have nothing to do with it

The housing shortage is exacerbated by Canada’s rapidly growing population (boosted by record-high immigration flows). On the supply side of the market, however, new housing construction (for both owned and rental properties) is being crushed by high interest rates and fears of a coming economic downturn.

Indeed, residential investment has declined every quarter since the Bank of Canada started increasing interest rates last spring. It’s fallen almost 20 per cent over the last year, and will certainly continue shrinking until the Bank’s monetary tightening is reversed.

Canadians need more housing, not less. The Bank of Canada argues strenuously that inflation has been caused by “excess demand”: that is, too much spending power. High interest rates do little to reduce the demand for housing. But they are hurting supply, badly.

So by lifting interest rates again to combat an uptick in inflation that was the result of its own policies, the Bank is continuing a self-defeating and ineffective strategy. In reality, post-pandemic inflation resulted not from Canadians having too much spending power, but rather from supply shocks and pandemic-related disruptions. High interest costs are making those supply shocks worse, not better –with Canada’s stressed housing market a prime case. All this sets the stage for more inflation down the road, or even worse: financial distress for many households, potential instability in the banking system, and a potential recession.

The vulnerability of Canadian households to rising interest costs has attracted growing concern from national and international bodies. Canada’s CMHC warned recently that since Canadians’ household debt was the highest in the G7 economies, families here are especially vulnerable to interest-induced financial distress. And a recent IMF report concluded Canada’s housing market was more at risk of mortgage defaults (due to inflated property prices and excessive household debt) than any other industrial country.

Statistics Canada data confirm that household interest costs are growing very rapidly in the wake of repeated interest rate increases. By end-2022, household interest costs were up by 45 per cent, or over $40 billion (at annual rates), compared to year-earlier levels. That’s $40 billion per year that households can’t spend on food, clothing, shelter, and other essentials – and that is instead paid directly to the banks. And this interest burden will get much worse still, as mortgage rates are adjusted and other contracts are rewritten.

Ironically, despite the high and precarious nature of household debt in Canada, political discourse continues to focus disproportionately on public debt and deficits – rather than on the financial stress faced by households. In fact, household debt is significantly larger as a share of GDP than government debt; the debt of non-financial corporations is even larger. Moreover, it is riskier and more expensive for private borrowers (households and corporations) to maintain and service their debt: they pay higher interest rates than governments, and face default risks that do not apply to governments. In that light, political leaders (like Pierre Poilievre) should stop fretting about government deficits, and instead focus on what’s required to lift Canadians’ wages, and reduce housing costs, so that households don’t have to run up such excessive debts just to put a roof over their heads.

Ultimately, Canada’s enormous household debt reflects the explosive interaction of financialized, speculative housing markets with the profit-driven impulse of private banking. Banks have an incentive to lend as much as they can to Canadians. That facilitates the escalation of housing prices: without the inflow of (once-cheap) credit, housing prices couldn’t possibly soar so high. But that, in turn, forces Canadians to take on still more debt – and so on and so on. Breaking this destructive feedback loop will require ambitious policies to expand supply of affordable, non-market housing. Then residents can literally pay for a roof over their heads, at a fair rate, with good stability and security for tenants – instead of being forced to “play the market”, and place bets on an enormous, speculative asset (namely, their own home).

Moving to non-market housing would pose an enormous challenge to both private property developers, who profit from financialized housing, and the banks, who profit from all this debt. But it’s the only way to break the cycle of borrowing and housing inflation that has created this dangerous overhang of debt for Canadians.

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