Bank of Canada set to lower the interest rate by end of 2025: Impact on Students
By Julianna Keskic, September 21 2024—
This year, there has been a steady series of cuts to the Bank of Canada’s policy interest rate, which directly affects prime rates for commercial banks and the interest they can charge on various lending products.
In meetings on July 22 and Sept. 7, the Bank of Canada has continued on its trajectory for monetary easing through interest rate cuts. The objective of the monetary easing policy is to preserve the value of money by keeping inflation low, stable and predictable. By the end of next year, the Bank of Canada hopes to reach its goal of an average inflation rate of two to three per cent from its current rate of 4.5 per cent.
What is the interest rate?
The following excerpt from The Bank of Canada website explains inflation and interest rate.
“If inflation is above target, the Bank may raise the policy rate which discourages borrowing and spending which eases the upward pressure on prices. If inflation is below target, the Bank may lower the policy rate to encourage financial institutions to lower interest rates and stimulate economic activity. This approach guards against both high inflation and persistent deflation.”
In an interview with the Gauntlet, Dr. Trever Tombe, the director of fiscal and economic policy at the School of Public Policy and a professor of economics at the University of Calgary, discussed the Bank of Canada’s monetary easing policy and the lowering of the interest rate.
“Inflation is just price changes. How quickly prices are rising can be affected by interest rates in a couple of ways. But the main way is that when interest rates are high, consumer spending … is going to fall because individuals are now needing to cover higher debt service payments [and] higher interest payments so there’s just less income available to spend on other things or some items that we buy,” said Tombe.
“So rising interest rates means that demand for goods falls and when demand falls prices tend to fall as well,” Tombe continued.
Impact of lowered interest rates on students and other age groups
Interest rates are being lowered to return to normal interest rate levels as inflation decreases. The impact on different age groups is varied, and depends on previous savings, mortgages and other debts.
“Now, who benefits from high interest rates? Generally old people, elderly Canadians typically don’t have a mortgage anymore. [They] have accumulated considerable savings and higher interest rates increase investment income savings. Those over 55 are doing better as a result of higher interest rates,” Tombe said.
For younger Canadians, it’s a complete reverse, Tombe explained. Younger Canadians have typically not accumulated savings, and have debt from student loans and mortgages. Those in the middle age group might have savings, but also large mortgages that are affected negatively by high interest rates.
Therefore, Tombe described how the current lowering of interest rates may be better for younger individuals than older. He elaborated on how those carrying debt will also have their burden eased by lowering rates.
“High interest rates are a real strain on younger individuals. lowering interest rates will be better for younger individuals than older. If you’re under 35, then [on average] about 10 per cent of your income goes to paying off debts. That’s a much higher share than what we see for older people. So small changes in interest rates can make that debt easier to carry,” Tombe said.
Housing and the interest rate
Dr. Tombe emphasized how shelter impacts decisions made by the Bank of Canada. Shelter is one of the prominent drivers of inflation if not the most influential. Shelter is factored in every time the Bank of Canada makes a decision regarding the interest rate and inflation.
“Shelter is one of the categories behind inflation that is basically driving everything right now. It’s not just that it’s a large contributor. It is the overwhelmingly dominant driver of inflation right now. and that’s mostly rent, but also costs of home ownership because of mortgage payments being high with high interest rates. Everything comes down to shelter at the moment. And this is an area where interest rates can have a big, but a complicated effect.”
Tombe explained that for anyone with a mortgage, especially one with a variable rate, the effect of changing interest rates is obvious. For renters, even though they’re not directly facing a mortgage cost, their landlord might and this may be passed through to renters in the form of higher rent.
In Alberta, additional pressure is added to the shelter-interest rate relationship that is not related to monetary policy and has everything to do with where people are moving in Canada.
Alberta’s population growth this year will be around 4.6 per cent with the possibility of reaching five million by the end of the year. Tombe highlighted that this rate of population growth is the fastest pace seen in the past century in Alberta, with only one exception. Tombe added that this leads to increases in the price of shelter rent as there is more demand.
Caution is needed while assessing what interest rate cuts will affect negatively. Tombe provided an analysis of why this is the case.
“If interest rates fall, that can lead to increased pressure in real estate, causing housing prices to start to rise again, translating into higher rents. This affects younger people more,” said Tombe.
Tombe described the income-housing relationship for renters and homeowners, to demonstrate why caution is needed when interest rates fall. According to Tombe, renters spend one-third of the income used to cover living costs. Homeowners, however, only spend about one-fifth of income used to cover shelter costs. If lowering interest rates makes housing cost pressures worse, then that’s not good for younger individuals, who often have to rent due to high down payments.
“It takes between a year and a half to two years for the full effect to work its way through. The Bank of Canada certainly has in mind a potential risk of lowering interest rates too much or too quickly as that may increase the pace of inflation again. That’s why they are being cautious and slow,” Tombe concluded.
For more information on the Bank of Canada’s monetary easing policy visit their website here. To learn more about the latest interest rate cut announcement read the article by the Globe and Mail covering the details on the decision at their website here.