How Could Canada’s Skyrocketing Debt Impact Mortgage Rates?

The Canadian government has added more than $360 billion to the national debt, all in an effort to soften the blow of COVID-19.

This economic threat, and Ottawa’s pandemic response, are unparalleled.

But some Canadians are getting worried. They fear an exploding national debt, one that’ll grow more than 55% to potentially over $1.2 trillion, is a ticking timebomb.

"The spending has gone too far—it's almost as though they have a short-term political approach of saying 'Who hasn't got money? We'll give it to them' as opposed to looking at the economy in a structural way," a Liberal insider reportedly told yahoo! Finance.

Others see the new level of debt as manageable and justified, given the grave economic consequences the country was facing.

The government itself estimates that despite the larger deficit, its interest payments will be $4 billion less this fiscal year than it had originally budgeted for. That’s assuming rates don’t increase, of course.

But while the economics may make sense today, thanks to historically low interest rates, eventually the piper needs to be paid, say critics.

"Are we so gullible as to believe even more borrowed money…won’t have to be repaid?" wrote Edmonton Journal columnist Chris Nelson.

He cites two options the government has to deal with this massive liability over the coming decade:

Print more money to buy the unprecedented debt our government is issuing

• This may sound like an easy solution, but growing money supply and a currency collapse could trigger rising inflation. Higher inflation leads to higher interest rates, which ultimately leads to lower economic performance.

Raise taxes.

• This is another hard pill to swallow given: a) Canada’s already steep tax burden, and b) the fact that increased taxes would inevitably slow economic growth, which the country desperately needs to pay its bills.

So, one way or the other, "in the end, we will pay," Nelson concludes. "Economists at TD Economics agree, noting that large deficits will "inevitably lead to higher taxes, unless central banks monetize government debt."

The Impact on Mortgage Rates

What does this have to do with mortgages? Well, both these options — higher taxes or money printing — would move mortgage rates.

Printing money would be bullish for rates in the beginning, meaning homebuyers could see mortgage rates begin to rise in the years to come.

For some who think this a likely outcome, locking into a 10-year fixed at today’s record lows seems appealing. Decade-long terms have dropped as low as 2.55% (an effective rate including cash back) for well-qualified borrowers in Ontario.

Should the politicians instead decide to raise taxes, we can likely kiss robust economic growth goodbye. In turn, in order to stimulate growth, the Bank of Canada would be incentivized to keep interest rates lower for even longer.

As we speak, no one knows how this story will end.

Will the government finance the bulk of its own debt and trigger inflation and higher rates?

Will Canadian bond buyers be turned off by the country’s record bond issuance and demand higher rates?

Will a stifling tax regime kill our growth prospects and keep rates perma low?

These are just some of the potential outcomes. It’s going to make a fascinating case study someday. But you may have to wait until 2030 to read it.