Bank of Canada Posts Largest Rate Hike in More Than 20 Years

The Bank of Canada recently hiked its target for the overnight lending rate to 2.5%, the largest rate increase since August 27, 1998.

With inflation persistently coming in (and expected to remain) above the Bank’s expectations, it raised rates by 100 basis points which, according to the Governing Council, was done “to front-load the path to higher interest rates”.

Shaun Cathcart, CREA’s Director and Senior Economist, Housing Data and Market Analysis, explained, “[A “front-loaded path”] implies the same end point for later this year, likely somewhere in the mid-to-low 3% range or slightly above what the Bank considers neutral (2% to 3%). That expectation hasn’t really changed since March, so the extra 25 basis points in July over and above what was expected may be 25 basis points they don’t do in either September, October or December. If that’s the case, then it’s like ripping off a BAND-AID—just get it over with because the fixed rate mortgage space has already priced most of it in anyway.”

The Bank noted several ongoing factors contributing to stronger inflation, stating, “while global factors such as the war in Ukraine and ongoing supply disruptions have been the biggest drivers, domestic price pressures from excess demand are becoming more prominent.” The Bank highlighted excess demand in Canada’s economy, tight labour markets, record low unemployment, labour shortages, and increasing wage pressures as domestic drivers of inflation.

The Bank also observed that with consumer and business expectations of inflation to remain higher for longer there’s an elevated risk inflation could become more rooted and difficult to combat. The Bank does not expect inflation to return to its 2% target until the end of 2024.

The Bank estimates Canadian economic growth was 4% in the second quarter of 2022 but is expected to slow due to a pullback in consumption and housing. Looking ahead, the Bank’s expectations for Gross Domestic Product (GDP) growth in the Canadian economy is now 3.5% for 2022, 1.75% in 2023, and 2.5% in 2024, with growth forecasts revised considerably lower this year and next compared to the Bank’s previous outlook published in its April Monetary Policy Report.

What does this mean for mortgages?

Canada’s major chartered banks are currently advertising five-year fixed mortgage special interest rates of around 4.81%.

Cathcart explains, “Rates have, very quickly, gone back to more normal levels…moreover, the Bank of Canada’s messaging increasingly suggests they’re planning on getting to the mid-to-low 3% range on the overnight rate but then stopping there. If that expected trajectory for interest rates is mostly priced into five-year fixed rates already, that means we’re already getting near the top for fixed borrowing costs.”

With the minimum qualifying rate for all mortgages being the greater of the mortgage contract rate +2% or 5.25% as set by the Office of the Superintendent of Financial Institutions and the Department of Finance, the stress-test hurdle in the fixed-rate space is now close to 7% for new borrowers. All mortgage applicants must qualify for financing based on an interest rate no less than the benchmark five-year lending rate, even if the mortgage is for less than five years.

The Bank of Canada’s next scheduled interest rate announcement will be on September 7, 2022. The next full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in its Monetary Policy Report on October 26, 2022.

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