Canadian businesses and households have had to endure an unprecedented tightening in financial conditions over the last year.
The Bank of Canada Policy Rate has risen 1,700% since March 2022, from 25 to 450 basis points. At the same time, the Canadian central bank has started to trim its balance sheet, selling around $90 billion of assets last year. The last time the country experienced a somewhat similar situation was in 2010, following the global financial crisis. Following this episode, the country experienced a relatively long period of slow growth and low inflation, which was ideal for real asset appreciation.
This time around, the Bank of Canada has had to grapple with a rapid rise in inflation. This has led the bank to correspondingly raise interest rates extremely quickly. The results are starting to filter through to the consumer via higher loan and mortgage rates, which in turn is already leading to a deceleration in consumer spending. Because the Bank of Canada is tightening quickly as the economy is slowing, CoStar predicts that Canada is already or soon will be in a recession.
Given this backdrop, it seems likely that the Bank of Canada will be forced to pause its tightening cycle sooner rather than later. Yet how long it keeps the rates at their current levels will be a function of how convinced the Bank of Canda is that inflation has been tamed. This could lead to a situation where the economic downturn is more severe than currently anticipated. It also makes the likelihood of a soft landing difficult to achieve.
In this context, a key issue for real estate professionals is preparing for the possibility that a more severe recession occurs sometime in the next year or so. Ensuring that leases are for longer terms with credit-worthy tenants will be key. At the same time, leasing professionals will likely need to gird themselves for tough negotiations with certain tenants likely to face economic difficulties in the coming quarters, especially in the office sector, which has already been hard hit by the rise of hybrid-work models.
At some point, economic growth will slow to the point where the Bank of Canada becomes convinced that inflation has been vanquished. Reaching this point may mean enduring a deeper economic slowdown. The silver lining is that once this occurs, interest rates will also move lower, which should kick off a new real estate cycle.