TD Chief Economist on Canada’s inflation fight and its impact on housing and consumers

Speaking of baselines, when I think about the Canadian consumer, we've had this wonderful baseline of not doing anything for debt. Rates have been so low for so long, so we've got another chart here showing that the cost to service debt is on the rise. How is that going to add into the equation? 

Yeah, it's pretty significant. That rise in the debt service ratio, if we just think through mortgage debt, it will add -- our forecast is that the Bank of Canada pushes the policy rate to 2.5%. So two more 50 basis point increases and then a couple more on the 25 side. So basically by the fall, we've already done what would normally have taken three, four years to do on an interest rate cycle, we will have done it in a very short six to seven months. And so that is an interest rate shock. And that will mean that, from a mortgage perspective, you're looking at an extra 2400, which we estimate by the beginning of next year in payments after tax income. So that's a lot. And then we have a high inflation environment and the Bank of Canada has shown us that there is that 5% inflation versus 2% inflation also takes another $2,000 out of your pocket. So combine these and you're looking at somewhere between $4,000 and $5,000, depending on how your debt is distributed out of your pocket after tax. So it obviously would suggest that you're going to have much slower consumer spending as we get into the second half of this year. But that is what interest rates are designed to do. They're intended to slow the economy, to kind of pull back the reins on what's happening on domestic demand. So I think we're in for some really good numbers in the second quarter. In consumer spending, there's a lot of pent up demand, a lot of money flowing into services. But that should not be continuing as the year goes on. And if it is, we would expect that the Bank of Canada would hike even more. 

What about housing? Canada's housing has been Teflon for years. We're starting to see anecdotally, I'd say, evidence of things starting to slow down. But what do you think is going to happen? 

We've got two months now in March and April where sales have come down and more than people expected. Now, the one thing is, is that we anticipated this type of phenomenon because we saw this big pull forward in activity when people were realizing rates are going to go up, all of a sudden everybody kind of jumped in on housing to lock down those low interest rates. And so now you're getting some payback. But at the same time, it's getting harder to qualify for a mortgage as we go forward and more expensive. And so that phenomenon will likely linger with us through the second and third quarter. And then we hope we go back to fundamentals. So that's a cyclical portion of the market. And then the fundamentals still speak to an economy in a country that has the highest population growth of any G7. We still have tight vacancy rates in the rental market. So there will be some sorting out and some pain to be felt in the next few months. But the hope is that the fundamentals ultimately drive you forward beyond that. 

Is there any concern, I guess, with the fundamentals return and things slowly cool off a bit? But the wealth effect is such a powerful thing for Canadians who, we've benefited from rising housing prices, we benefited from a rising stock market. You put it all in there and there could be some real negative impact on how people are feeling about their spending in the economy. 

Yeah. So just to give a concept of how much of the wealth effect we've had. Just on real estate prices, if we have a 15 to 20% pullback from the peak, which would have been around February, March of this year, you're still looking at a 25% gain since the pandemic. So over two years, that's a pretty healthy return. You would need something like quite shocking in terms of 50% pullback in prices, which really would be very difficult to orchestrate in the absence of like full blown out recession dynamics. So there's still a wealth dynamic feeding through. Certainly, the stock market is not that area these days. But on housing, one of the reasons Canadians gravitate towards it is because it tends to have a steadier movement, less volatility than the stock market. And by the same token, people spend differently out of housing wealth than they do out a stock market wealth, which they view as more fleeting. Housing wealth tends to have more endurance and people behave differently with it. 

This puts the Bank of Canada, and they've been very clear in telegraphing again with the central bank in the States about they're going to be firm. Inflation matters, they're going to do what they need to do. But still, it's a tightrope they have to walk it. 

It's a tightrope for the reasons I mentioned, that they're trying to get this growth level to ease enough to take demand and pressure off your resources, whether it's labor or it's inputs. And there can be some misses here. The challenge for the central banks is the policy error was that they have waited so long that now they've got to rush this cycle on interest rates. And that's the opposite of what they've been telling us for decades. It's better to go early and slow than be behind the ball and go fast because interest rates feed through with such a lag in the economy that you need to create space to observe how consumers and businesses are absorbing it. And unfortunately, they've compressed the cycle. And I think that's what the market's realization is, is like we may not know we had a message over six months past the peak of the rate cycle. You're still absorbing that impact. And that's the tightrope they're walking. Creating the confidence in the economy that they've got it right. But at the same time, we want to actually be able to observe the metrics in real time. It's going to be lagged. 

Yeah. Thanks very much. Great conversation, as always. 

Good to see you, Kim.