Tariffs and How they Affect Canadian Mortgage Rates

Posted February 20, 2025

What are Tariffs

Tariffs are taxes or duties imposed by a government on imported goods and services. The goal of tariffs is typically to protect domestic industries by making imported goods more expensive, thus encouraging consumers to buy locally produced products. They can also serve as a source of revenue for the government.

There are different types of tariffs, including:

1. Ad valorem tariffs: A percentage of the value of the imported goods (e.g., 10% of the product’s value).
2. Specific tariffs: A fixed amount based on the quantity of the goods, such as $5 per ton of steel.
3. Compound tariffs: A combination of both ad valorem and specific tariffs.

Tariffs can influence trade relations between countries, as they often lead to retaliatory measures, where one country imposes tariffs in response to another country’s tariffs.

How Tariffs increase may increase mortgage rates

The increase in tariffs on goods imported to Canada can lead to higher Canadian mortgage rates through several economic mechanisms. Here’s a detailed breakdown of how this happens:

1. Increased Production Costs and Inflation

• Higher Import Costs: When tariffs are raised on goods imported into Canada (such as steel, aluminum, or consumer products), the immediate effect is that these goods become more expensive. This increases the cost for Canadian businesses that rely on these imports to manufacture products or for retailers who resell them.
• Inflationary Pressure: As the prices of goods rise due to the higher tariffs, there’s an increase in the general price level of products in the economy. This can lead to inflation, as businesses pass on the higher costs to consumers.
• Cost of Living: Inflation can increase the cost of living for consumers, putting pressure on household budgets. This, in turn, can affect the overall economy and increase uncertainty, especially if it leads to higher interest rates to combat inflation.

2. Central Bank’s Response to Inflation (Bank of Canada)

• Rising Inflation: The Bank of Canada (BoC) monitors inflation as a key indicator of the economy’s health. If inflation rises too quickly due to higher tariffs (and the associated increase in consumer prices), the BoC may decide to raise interest rates to curb inflation. This is because higher interest rates tend to slow down spending and borrowing, helping to reduce inflationary pressures.
• Raising Interest Rates: When the BoC increases interest rates, the cost of borrowing rises for both consumers and businesses. This includes mortgage rates, which are often tied to central bank rates. Therefore, an increase in the central bank’s key interest rate leads to higher mortgage rates in Canada.

3. Impact on Borrowing and Mortgage Rates

• Higher Borrowing Costs: When interest rates increase, banks and financial institutions raise their own borrowing rates, which include mortgage rates. This is because they generally pass on the higher cost of borrowing from the central bank to consumers. So, Canadians will face higher rates on their mortgages, making it more expensive to take out loans or refinance existing mortgages.
• Reduced Consumer Spending: Higher mortgage rates also lead to reduced disposable income, as homeowners now have to allocate more of their income to pay for their mortgage. This can further slow down economic growth because people are spending less on goods and services. However, the Bank of Canada may still raise rates to manage inflation, even at the risk of reducing consumer spending.

4. Global Trade and Currency Effects

• Exchange Rate Effects: Tariffs can also affect the exchange rate between the Canadian dollar and other currencies. For instance, if other countries retaliate with their own tariffs on Canadian goods, the Canadian dollar could weaken. A weaker Canadian dollar makes imported goods more expensive, leading to even higher inflation, which could prompt the Bank of Canada to raise interest rates to stabilize the economy.
• Global Economic Influence: If global trade becomes more expensive or less predictable due to tariffs, this can create uncertainty in financial markets. In uncertain environments, lenders often raise interest rates to compensate for perceived risks, which can also contribute to higher mortgage rates in Canada.

How tariffs may affect housing costs

1. Increased Construction Costs

• Rising Material Costs: Many construction materials in Canada, such as steel, lumber, and aluminum, are imported. If tariffs are imposed on these materials, their prices increase. For example, higher tariffs on steel and aluminum can directly increase the cost of building homes, as these materials are critical for constructing residential buildings, especially for infrastructure like framing, roofing, and siding.
• Impact on New Housing Supply: With higher construction costs, developers may find it more expensive to build new homes, leading to fewer new housing units being built. If housing supply decreases while demand remains steady or increases, this can exacerbate the housing affordability crisis. The reduced number of available homes puts upward pressure on prices for both new and existing homes, making them less affordable for the average consumer.

2. Higher Mortgage Rates

• Cost of Borrowing: As discussed earlier, tariffs can contribute to inflationary pressures, which may prompt the Bank of Canada to raise interest rates in an attempt to control inflation. When interest rates rise, borrowing becomes more expensive. As a result, mortgage rates increase, making it harder for Canadians to afford home loans.
• Affordability Squeeze: For potential homebuyers, higher mortgage rates mean that monthly payments for the same home will be more expensive. This can price out first-time buyers or those with limited incomes, who are already struggling to enter the housing market. For existing homeowners, higher mortgage rates could make it harder to refinance or service their current mortgage, increasing financial strain.

3. Higher Cost of Living

• Inflationary Effects: Tariffs on imported goods raise the prices of everyday items like consumer products, food, and other goods. As inflation rises, Canadian households face a higher cost of living. This leads to less disposable income available for housing expenses.
• Strain on Household Budgets: When more of a household’s income is spent on essentials due to inflation, there is less money available for housing, whether it’s for rent or homeownership. As rents and home prices rise due to higher construction costs, consumers find themselves in an affordability bind, struggling to keep up with the combined cost of living and housing.

4. Wages and Income Growth

• Stagnant Wage Growth: While the cost of living rises due to higher tariffs, wages do not always keep pace. If businesses face increased production costs (due to tariffs) but cannot raise prices on goods or services significantly due to competition or market conditions, they may not be able to offer higher wages.
• Income Inequality: Tariffs disproportionately affect lower-income households, as they spend a higher percentage of their income on goods that are subject to higher prices. As the cost of living increases, those with lower or fixed incomes may find it increasingly difficult to afford basic necessities, let alone housing. This growing income inequality can make housing unaffordable, especially for first-time buyers or renters in higher-demand urban areas.

5. Weaker Consumer Confidence and Economic Uncertainty

• Economic Uncertainty: The introduction of tariffs can create economic uncertainty in both the domestic and global markets. Businesses may become more cautious, delaying investment in housing or development projects due to the uncertainty about future costs, trade relations, and overall economic stability.
• Impact on Housing Demand: A reduction in consumer confidence could lead to a slowdown in the housing market. Potential homebuyers may hesitate to purchase homes if they fear the economy could slow down or if they worry about rising interest rates or inflation. However, even with reduced demand, the lack of supply due to higher construction costs (from tariffs) could maintain upward pressure on prices, exacerbating affordability issues.