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BoC rate hike unlikely to shift consumer behaviour: experts

People visit an open house for sale in Toronto, Friday July 14, 2017.

Mark Blinch/Globe and Mail

Lynsey Foster and her husband bought three properties in Southern Ontario in recent years when the Bank of Canada's benchmark interest rate was hovering around 1 per cent.

Ms. Foster, a 28-year old realtor, said her knowledge of the real estate market and the low interest rates "allowed us to make strong investments and to expand our portfolio much quicker than we would have been able to with stocks and mutual funds."

Ms. Foster is part of a generation of Canadians who have spent the past decade of their lives in a falling interest rate environment, enjoying easy access to debt and low borrowing costs.

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Now the Bank of Canada is attempting to wean Canadians off low interest rates, raising rates by one-quarter percentage point to 0.75 per cent and signalling that additional increases could be on the horizon.

Explainer: How the rate hike affects homeowners and buyers

Rob Carrick: Five harsh realities of rising rates for savers and borrowers

But what will it take to change consumer behaviour with Canadians young and old accustomed to low rates?

"In order to change their behaviour, they need to change their belief of the world," said Claire Tsai, co-founder of the University of Toronto's behavioural economics research centre.

But changing that behaviour is likely to take much more than one or two rate hikes.

For nearly a decade, rates have remained close to 1 per cent. The Bank of Canada, along with the U.S. Federal Reserve and other central banks, slashed interest rates in order to help stimulate their economies after the 2008 U.S. housing meltdown and global economic recession.

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By 2009, Canada's benchmark interest rate was 0.25 per cent. A year later, the Bank of Canada started raising rates, though never pushed the level above 1 per cent. Then in 2015, the central bank cut rates twice to deal with the energy downturn.

For many Canadians, low rates have become the new normal. Last week's 25 basis point increase to 0.75 per cent is still very low, especially compared to the past. In the 1990s, interest rates were above 8 per cent and in the 1980s, rates were above 10 per cent.

"People are concerned. But when they look at what a rate hike actually means and that it only affects a portion of people, not everyone, they become less concerned," said Brian Hogben, a mortgage broker in Hamilton. "Many people who are already in fixed interest rates are concerned as well, until they realize this does not affect them," he said. Mr. Hogben recommends that homebuyers "stay the course" with variable mortgages.

One economist said the low-rate environment has become so normal for some Canadians, that in order for them to change behaviour, the evidence and the pain of paying higher rates would have to become so unbearable that it would cause them to break from the past.

"You would need sustained increases and material increases," said Jason Stewart, an economist who conducts behavioural research for the private and public sector at BEworks Inc. "Twenty-five basis points is a signal but we don't know its duration and we don't know its intensity, meaning, how long is it going to last and how much is it going to be?" he said.

However, increasing interest rates back to their historical norms will be tricky for the Bank of Canada.

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The decade of low rates combined with skyrocketing real estate prices has fuelled the biggest debt binge in Canadian history. As of the end of March, the ratio of household debt to disposable income was sitting near a record high of 166.9 per cent. Statistics Canada says that means Canadians owed $1.67 for every dollar of disposable income.

If rates increase too quickly or to a level where homeowners have a hard time making their mortgage payments, the central bank's actions could lead to mortgage defaults, financial instability and economic woes.

Since the central bank raised rates last Wednesday, the Big Six Canadian banks have all boosted their prime lending rates to 2.95 per cent from 2.7 per cent. The higher prime rate has increased borrowing costs on home equity lines of credit and variable mortgages.

Amos Nadler, assistant professor of finance at the Ivey Business School, said if people are anticipating a greater loss, they may act sooner rather than later. "There may be a temporary increase in demand for securing financial products now," he said.

But overall, it is unlikely that last week's rate increase will lead to a shift in consumer behaviour.

"The primary driving force of economic behaviour is fear," said Paul Smetanin, president with the Canadian Centre for Economic Analysis, who is 49 years old and noted that his first mortgage had an interest rate of 14 per cent. "I don't think that the fear factor has gone up," he said.

Another home buyer, 26-year-old Jacob Jackson, said he was expecting a rate hike and took out a five-year fixed mortgage when he purchased a multiunit property in Hamilton with his partner in April of this year.

Mr. Jackson and his partner live on one floor and rent out the other two units. The rental income covers their monthly mortgage payments, property taxes and house insurance. Now Mr. Jackson is deciding whether to use savings to pay down the principal on his house or use the funds to invest in another asset class, such as equities.

Ms. Foster, the realtor and investor, said she is happy with her investments. Ms. Foster and her husband made 20-per-cent down payments on their three properties, which were purchased for less than $800,000 in total. They have already sold one house for a profit.

"We will continue to buy properties. If our properties were variable, our expenses would change by $48 per month, not enough stress to take us out of the market," said Ms. Foster.

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About the Author
Economics Reporter

Rachelle Younglai is The Globe and Mail's economics reporter. More

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