Soaring Supply Of Canadian Dollars Could Mean Higher Borrowing Costs Ahead, Experts Say

If you’re looking at maxing out the credit limit on your next house purchase, you may want to reconsider. Mortgage rates are likely to head higher sooner than expected, experts say.

The low-interest party could soon be over for deficit-spending governments as well.

That’s because the economy stands to recover faster from the pandemic than forecasts had projected, which could force central banks to cut back on the emergency support.

Data from Statistics Canada last week showed the economy grew at a nearly 8-per-cent annual pace in the final months of 2020, much faster than the 4.5 per cent the Bank of Canada had been expecting.

And with vaccines rolling out, the end of the pandemic is coming into sight, meaning a return to normal life could be around the corner.

Watch: Recovering industries could trigger inflation, Kansas City Fed warns. Story continues below.

That creates a new problem: The enormous amount of new cash sitting in our financial system, which central banks started printing at the height of the crisis last year.

In just the past year, Canada’s money supply has grown by nearly 19 per cent, causing some economists to worry about the possibility of out-of-control inflation.

So far, that inflation hasn’t happened because people haven’t been spending their money, economists at CIBC said in a report issued Tuesday. Recent data from the OECD shows that Canadians’ savings rate quintupled during the pandemic .

But when people come out of lockdown and start spending again, that could change quickly. This new hoard of cash could flood an economy that has fewer things to spend on than before, driving up prices.

“The money supply growth we’ve seen is unprecedented in normal, moderate inflation times, and isn’t consistent with a 2-per-cent inflation target,” CIBC economists Avery Shenfeld and Andrew Grantham wrote.

In other words, central banks will have to slow down money-printing through their quantitative easing programs maybe as early as this year, the CIBC economists predict, and that could mean higher borrowing costs for the government, unless it cuts back on deficit spending.

Meanwhile, the conditions that create inflation a lack of slack in the economy could come as soon as next year, said Derek Holt, vice-president and head of Capital Markets Economics at Scotiabank. That could push up the date when the Bank of Canada starts raising interest rates.

“The prudent thing to advise heavily indebted Canadians is to plan their finances around rate hikes commencing considerably sooner than the Bank of Canada has guided even up to last week’s announcements,” Holt wrote in a client note Friday.

Canadian household debt jumped to around 112 per cent of annual economic output in the third quarter of 2020, up from around 102 per cent before the pandemic. Canadian households are among the most indebted in the developed world, and so are more sensitive to changes in interest rates than households in many other countries.

Household debt as share of GDP

Governments, too, will have to “allow for the likelihood that interest rates will on average be higher in the coming decade than they are today in considering how large a deficit we can run on a persistent basis,” Shenfeld wrote in an email to HuffPost Canada.

Canada’s government debt levels were lower than average for a developed country going into the pandemic, but the federal government’s pandemic spending amounted to the largest of any developed country , relative to the size of the economy. 

Canada is now projected to be middle-of-the-pack on government debt among advanced economies all of whom are more indebted now than before COVID-19.

Assuming higher interest rates should be part of the “fiscal anchor” the federal government has promised to deliver on, Shenfeld added.

“To avoid an inflationary overheating in the economy, Ottawa has to stay attuned to the pace at which the private sector will recover in the next two years,” Shenfeld wrote. 

“If all goes as planned on the vaccine front, we might be in the fortunate position of not requiring as much stimulus spending as planned for 2022 or 2023. In the very near term, the economy still needs a fair bit of help.”