The Bank of Canada delivered another 25 basis points to the economy Wednesday — increasing the central bank’s overnight rate to 5.0 per cent. This furthered a historic tightening in monetary policy that brought interest rates from record lows back to rates we haven’t seen since the 2007-08 financial crisis.  

For many, this feels like the final nail in the coffin that appeared to be sealed with the prior rate hike — and just as many are hoping it is just that — the final one. 

Tiff Macklem, the governor of the Bank of Canada, isn’t so sure, stating in no uncertain terms that they’re not opposed to continued increases should they be required. 

It seems that the real estate market sentiment immediately felt the impact of the last unanticipated hike, which only one major bank economist predicted. Perhaps it was another small warning shot, like the opening 25 basis point hike in February of 2022. It appears to have accomplished just as much; anecdotes of distress among homeowners continue among real estate professionals, with many publicly expressing their empathy towards those struggling. 

Realtors are now reporting increased calls from owners who are contemplating selling due to sustained pressure on renewal or increases to variable rates. 

Commercial bank prime rates have now moved to 7.20 per cent. This means that variable rate mortgages will be found in the 6.0 per cent Range, and HELOCS reach over 7.50 per cent for most borrowers. This is a sharp increase from the rates of around 3 .0 per cent that gave the market extreme confidence during the height of the pandemic era.  

Bond market response

The Canada 5-Year Government Bond yield fell consistently throughout the day on Jul. 12 after the rate hike announcement, dropping from 3.950 per cent at open to 3.812 per cent at close. Yields have been relatively steady within this range, which is an important consideration, given that this is the primary pricing mechanism for fixed-rate mortgages. 

In Canada, fixed-rate mortgages are closely tied to government bond yields, particularly the yield on Government of Canada bonds with similar maturity periods. As bond yields increase, lenders need to increase their mortgage rates to make mortgages more competitive investments against those bonds. Otherwise, banks would just put their money into bonds, which are considered one of the safest places to invest. The banks typically apply a risk premium to mortgage products, so they’ll typically price a product at “GOC+2” or the bond yield plus 2.0 per cent. With current yields, this would give us mortgage rates in the high 5.0 per cent or low 6.0 per cent range. 

Conversely, when bond yields decrease, fixed mortgage rates tend to follow suit, becoming more affordable for borrowers. Therefore, fluctuations in Canadian bond yields play a significant role in influencing the direction of fixed mortgage rates in the country.

This is really where the difficulty lies for the Bank of Canada. The majority of purchasers today are buying with fixed-rate mortgages simply because the pricing is better than variable-rate mortgages. So by increasing the rate, the central bank isn’t really having an impact on the demand side of the equation; they’re putting pressure on the supply side of the equation by creating financial stress and, with it, the incentive to sell properties. By the sound of it, that’s exactly what they’ve done, as more and more sellers are admitting defeat to the Bank of Canada, with new supply growth generally outpacing sales for the first time in a while.

Focus shifts to housing

The Bank of Canada’s attention to the housing market became evident in its Quarterly Monetary Policy report. Furthermore, during the Bank’s subsequent press release, it appeared that Governor Macklem is relying less on unemployment as a key performance indicator (KPI) and increasingly looking at the housing market and immigration to establish a range of potential outcomes for the Canadian economy.

Macklem stated during the release that “When we raised interest rates, we saw housing slow quite sharply. It is true that they didn’t slow as much as we thought they would…housing has ticked back up.”

At the beginning of this comment, Macklem references last year’s historic drop in house prices, which commenced after the initial rate hike in February, resulting in a year-over-year drop in house prices of almost 20 per cent. This drop exceeded 1989, Canada’s previous record “crash” in house prices.

Strength or seasonality?

The strength being referred to in Macklem’s statement is indicative that the BoC may be ignoring seasonality in house prices, though the monetary policy report shows seasonally adjusted data. By most measures, the market isn’t strong on paper, especially on the volume side, with sales numbers significantly lower than in a typical spring market. Most of the growth seen in house prices in Canada year-to-date seems to be in line with seasonal growth, with a slight increase above the norm.

The Bank of Canada revised their projections on house prices, stating that “Faster-than-expected pickup in housing resales, combined with a lack of supply, has pushed house prices higher than anticipated in January. The previously unforeseen strength in house prices is likely to persist and boost inflation by as much as 0.3 percentage points by the end of 2023, compared with the January outlook.”

During the press conference, Bank of Canada Deputy Governor Carolyn Rogers cites supply scarcity and excess demand from population growth as forces supporting housing growth. This strength isn’t necessarily reflected in their GDP projections — in which they indicate they expect housing to be a negative contributor to GDP growth in 2023.

No end in sight

Now we get to the big questions: is it over yet? When does this end? When does it get better?

Macklem originally suggested that 5.0 per cent may be his terminal rate or the rate at which he stops hiking. The overnight rate has finally eclipsed the rate of inflation in a meaningful way. This means that adjusted for inflation, the real interest rate is now positive.

Real interest rate = nominal interest rate – inflation rate

Typically, the nominal interest rate needs to meet the inflation rate before reversion begins. On average, interest rates stay at their peak for nine months before rate cuts begin.

Feature image source: Twitter, @bankofcanada