The Bank of Canada and the U.S. Federal Reserve have reduced their benchmark rates significantly since last year, yet the average mortgage rate has declined by far less.Jonathan Hayward/The Canadian Press
John Rapley is a contributing columnist for The Globe and Mail. He is an author and academic whose books include Why Empires Fall and Twilight of the Money Gods.
Since the summer of 2024, the Bank of Canada has reduced its benchmark interest rate by nearly three percentage points. Yet the average Canadian mortgage rate has fallen by less than a third of that, and the decline pretty much stopped this year. It’s the same south of the border. This week’s cut by the Federal Reserve brought the total reduction in its target rate since last year to 1.75 percentage points, yet the average mortgage rate has come down only half that. That’s probably the end of it, too. Henceforth, mortgage rates will either stay where they are or go higher.
Ordinarily, when central banks cut interest rates, interest rates across the board follow. But we have not been living in what have been ordinary times, from the vantage point of central banks. Western central banks have long had dual mandates: keep inflation low and employment high. But until the global financial crisis of 2008, stung by the experience of the high inflation of the 1970s, they tended to focus mainly on inflation, the belief being that low inflation would itself deliver a healthy economy.
Thus, central banks tended to set interest rates to counterbalance the government’s fiscal policy. When governments were spending a lot, they would raise interest rates to take money back out of the economy – since higher rates cause people to spend less on credit, save more and pay off debts – and cool things down. When governments cut their spending, central banks would reward them by cutting rates, allowing consumers and business to take advantage of cheap credit to boost their spending. And by and large, through the 1980s and ’90s, that approach worked reasonably well.
But the recession that followed the 2008 crash upended those assumptions. As inflation plunged, central banks slashed interest rates, but economies barely budged. So central bankers began experimenting with new approaches, such as the use of quantitative easing, which directly injects money into the economy to stimulate demand.
QE was always controversial, but at least for a while, it seemed to work, digging economies back out of recession without initially stirring inflation. But the main upshot was that, just as a previous generation of central bankers had been traumatized by 1970s stagflation to focus obsessively on keeping inflation low, the current generation had been shaken by the economic crisis of this century, when the world economy appeared to be on the verge of collapse.
Bank of Canada holds interest rate at 2.25%; U.S. Federal Reserve cuts for third consecutive time
So single-minded did the central banks’ focus on maintaining economic growth become that inflation became secondary, so much so that when it began to reappear a few years ago, it was waved off as “transitory.” That, as we now know, turned out to be a huge mistake that toppled several governments when they were blamed for the high cost of living.
In the interim, though, investors and governments had grown so accustomed to endless cheap money that they came to assume central banks would always keep interest rates low to prevent any kind of recession. Borrowing went through the roof, and today the scale of both government and private debt in Western countries has reached historically unprecedented levels.
Which brings us back to mortgage rates. What we are now being reminded of is that while central banks can set the short-term rates at which private banks obtain credit, longer-term mortgage rates are set in bond markets, where governments and businesses raise long-term credit. With the debts of Western governments rising across the board, competition for credit is enabling bond investors, like pensions and hedge funds, to demand higher returns. Meanwhile, the fact that central banks seem less anxious about inflation is causing bond investors to further guard against its possible resurgence by demanding higher rates of interest on their loans.
Bank of Canada’s interest rate hold may bring homebuyers and sellers off the sidelines
Unless central banks are willing to resume quantitative easing and buy bonds at prices investors won’t accept, something most of them no longer want to do, they can’t push long-term rates down. Borrowers – both households and governments – could take advantage of the lower rates on short-term credit by switching to variable loans. That is, in fact, what many governments are now doing. But that leaves them vulnerable to a rise in interest rates, which bond investors now expect to happen in most developed economies next year.
In the United States, though, the Trump administration is pressing the Federal Reserve to cut rates aggressively, while the Treasury Department has been doing most of its borrowing in short-term markets. That way it issues fewer bonds, which keeps supply low, prices elevated and interest rates down. Nevertheless, bond yields have been rising, and the dollar is weakening as global investors retreat. Even the U.S. can’t beat the market indefinitely.
The era of cheap money has reached its limit, and we’ve entered a new regime. Like it or not, these are the kind of credit costs we’ll have to learn to live with.