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Economy vulnerable to higher interest rates, Bank of Canada hints

Economy vulnerable to higher interest rates, Bank of Canada hints

Despite resilience after a year and a half of the pandemic, Canada’s economy remains fragile and could be undermined by higher interest rates, the Bank of Canada’s deputy governor suggested on Tuesday, two weeks before the next key rate decision.

Speaking to the Ontario Securities Commission, Deputy Governor Paul Beaudry noted that the pandemic has changed the country’s financial landscape.

He remembers that even before the arrival of COVID-19, in 2019, one in six Canadian households had a debt-to-income ratio above 350%.

Since then, many families have managed to improve their situation. “On average, Canadians have saved an additional $8,300 since the start of 2020,” Beaudry said, attributing the improvement to financial assistance from the government and to the fact that it was difficult to spend, requiring reservations.

In doing so, many families were able to pay off consumer debt and speed up mortgage payments, while the number of personal bankruptcies has reached an all-time low.

On the other hand, the pandemic-induced housing escalation, which has led to record home prices month after month, while buyers have taken advantage of ultra-low interest rates, is dampening the recovery.

“Since many households have taken advantage of the long period of historically low interest rates to take on heavy debt, it is likely that the economy will now be more sensitive to any increase in borrowing costs,” the deputy governor warned.

Mr. Beaudry fears that “the debts that have accumulated on households in the context of low interest rates will not be repaid any time soon,” especially since “the gap between supply and demand that has driven home prices up during the pandemic remains.”

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“Despite the resilience of Canadian banks, these weaknesses could exacerbate the economic impact of a significant interest rate hike or a significant negative shock,” Paul Beaudry concluded during his presentation.

The Bank of Canada cut its key interest rate to 0.25% at the start of the pandemic to stimulate the economy. The headline rate has not risen since then, despite an accelerated increase in inflation of more than 5% in one year in Quebec, according to the latest data from Statistics Canada.

The next key interest rate update is expected on December 8th. However, during the last update in October, the Bank of Canada warned that it does not plan to raise the key rate before the second or third quarter of 2022.