The past couple of years has been anything but ordinary for the entire world. The combination of the COVID-19 (coronavirus) pandemic, the Russian invasion of Ukraine and rampant inflation have all caused massive economic uncertainty across the world.
However, the way each country handles each macroeconomic shock is critical to that country’s well-being; Canada, for instance, has been on a steady road to recovery since the pandemic peaked in summer 2020.
However, as with almost every other nation, Canada has endured a plethora of economic challenges stemming from the pandemic, including a three-decade high inflation rate, a record high household debt to disposable income ratio, volatile commodity prices and much more.
As a result of all these adverse economic conditions, the Bank of Canada has been forced to begin steadily raising interest rates from its record low of 0.25% in 2021.
What do rising rates mean?
Interest rates are one of the central bank's most useful tools to stimulate or restrict economic activity.
Periods of low interest rates mean that borrowing money will be less expensive, encouraging people to invest and spur economic activity.
However, during prolonged periods of low interest rates, inflation may begin to spiral out of control as there is too much economic activity, causing prices of everyday items to increase.
Conversely, as interest rates begin to rise, consumers begin to restrict the amount they invest since the cost of borrowing has increased, causing economic activity to slow down, which then enables inflation to stabilize.
Since a steady inflation rate is beneficial to any economy, the target rate tends to be around 2.0%. Currently, Canada’s inflation rate rose to 6.7% in March 2022, hitting a 31-year high.
Inflation growing too fast typically makes consumers’ lives less affordable as the prices of everyday items increase and wages remain steady.
On the other hand, raising interest rates can also do harm as more people's loans get refinanced, while some end up defaulting. If delinquencies spike, a full-out financial crisis may occur as a result.
Canadian confidence
Despite continuously rising interest rates, the Superintendent of Financial Institutions (OSFI) forecasts that the Canadian economy is in good enough shape to handle high interest rates.
For example, the Canadian economy is currently working to become greener by expanding its renewable power industry, manufacturing more electric vehicles and incentivizing businesses to upgrade to energy-efficient processes.
This type of goal is a consistent method to keep economic conditions afloat by always having something that needs to be improved or worked on.
In addition, the Canadian banking system is highly regulated in terms of loan origination and the issuance of general bank licences.
The OSFI is responsible for maintaining confidence in Canada’s financial system, constantly regulating and issuing guidelines for banks to follow.
For example, consumers must be able to pass a stress test before they can get an insured mortgage. This test will help banks better identify the risk if a borrower defaults on their loan.
This will also help ensure that most people who got approved for a mortgage after April 2020 will be able to continue to make payments even if their mortgage increases.
Final thoughts
Overall, the Canadian economy is forecast to endure many challenges ranging from high inflation to general economic uncertainty.
However, due to Canada’s strict regulations on financial institutions, economic conditions are expected to be more resilient to rising interest rates, as banks are better at identifying risky borrowers with the stress test.
In addition, Canada’s economic expansion goals to become a greener nation may also be attributed to its expected resilience to increasing rates.
