Why negative real interest rates are a problem for the Bank of Canada

If the Bank of Canada raises its key overnight rate by 75 basis points next week, as a number of economists are now predicting, the biggest rise in borrowing costs in decades will have seen the rate bank manager go from just 0.5% to 2.25%. in less than five months.

Steep as that sounds, however, soaring inflation means real interest rates are at historic lows, which could pose a problem for the central bank as it tries to cool down the markets. loans.

Real interest rates, which are obtained by subtracting the rate of inflation from the central bank’s policy rate, are essential for making investment and savings decisions.

For savers, inflation eats away at nominal returns. The reverse is true for borrowers who can obtain fixed interest rate financing, as inflation reduces the amount they have to repay in real terms.

In a new article, TD economists James Marple and Faisal Faisal illustrate the stimulative power of negative real rates. They cite the example of a Canadian household taking out a five-year fixed rate mortgage at the current posted rate of 4.6% to purchase a home at the average price. If average inflation is only one percentage point higher than expected, this household will save almost $6,500 in current dollars, which economists say is equivalent to cutting the annual mortgage rate to about 3, 4%.

“The higher the expected rate of inflation relative to nominal borrowing costs, the more attractive borrowing becomes today,” they write. “If inflation expectations continue to drift higher, central banks will have to go even further to bring it into line.”

The Decoder is a weekly feature that unveils an important economic picture.

Your time is valuable. Receive the Top Business Headlines newsletter in your inbox morning or evening. register today.

Comments are closed.