Central banks, interest rates and the cascading effects on real estate

This year’s battle of the central banks against inflation started with the Federal Reserve in the U.S. with rate hikes in March and continued on Nov. 2, with the latest increases pushing the Fed's rates from their low of 0.25 per cent to four per cent, a 16-times appreciation.

It is one of the steepest and sharpest increases ever seen.

The central banks from countries that did not follow the U.S. Fed (the Bank of Japan, for example) saw their currencies devalue significantly against the U.S. dollar (JPY lost over 30 per cent value from March 2022). The Bank of Canada kept pace with the U.S. Fed with the policy interest rate climbing 7.5 times from 0.50 per cent in March 2022 to 3.75 per cent , yet the Canadian dollar still lost over 10 per cent versus the U.S. dollar during this time period.

Arguably it could have lost a lot more had Canada taken a different approach to interest rates.

Spinoff effects felt in Canada, around world

These rate hikes by the central banks have also sparked a horrible escalation in the bond markets, destroying the prices of the existing bonds and, of course, causing havoc to both the short-term and long-term borrowers.

The strong U.S. dollar also caused significant damage to sovereign nations, with Sri Lanka going through a major economic crisis and the United Kingdom (a G7 country) seeing its pension funds get stuck in a “doom loop”, where banks had to sell government bonds (known as gilts) to meet their cash calls on the leveraged investments.

The commercial real estate industry in Canada is of course impacted by the macro world around us.

The five-year mortgage rates spiked from less than two per cent to five per cent, causing borrowers to lose over 30 per cent of their borrowing power “overnight.” This translates in it being impossible for properties to retain their sale values from 2021 to today.

For the sellers who were aware of the price they could get in 2021 but need to sell today, the decision becomes convoluted: either sell today at lower values, or hold on hoping interest rates will go lower over the next 12 to 24 months.

Unfortunately, no one seems to know where we are going from here, not even central banks which are using rear-view-looking indicators such as unemployment data or inflation numbers to assess their current and future policy rates.

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