Another Bank of Canada interest rate decision is soon upon us and as the end of the hiking cycle draws near, it promises to be a cliff hanger.
The central bank has raised its benchmark interest rate at a record pace of 400 bps in nine months to 4.25 per cent, and said after its last increase that a decision to raise rates further would depend on the data.
Most expect another hike tomorrow, and the market is putting high odds on a quarter-point increase, which would take the rate to 4.5 per cent.
But data have failed to provide a 100 per cent clear answer either way, and some economists are arguing that the Bank should hold fire.
“Those who argue that another 25 basis points increase will not kill the economy forget that at this stage of the business cycle, the impact of further hikes is not linear. In other words, the marginal increase could be the straw that breaks the camel’s back,” wrote National Bank economists Matthieu Arseneau and Taylor Schleich.
Signs of stress have been showing up in the Bank of Canada’s own indicators, says Capital Economics. The Bank uses the share of new mortgage borrowers (including renewals) with a debt service ratio of more than 25 per cent of income to identify financially vulnerable households. That share has grown from 12 per cent before the Bank started hiking to 27 per cent in the third quarter. Capital calculates that the share is on track to reach 35 per cent this quarter.
“We suspect the Bank is more concerned about the financial risks of its actions than it has let on so far,” said Capital economist Stephen Brown.
Homebuyers, struggling with the highest borrowing rates in almost 20 years, may also soon face tougher mortgage rules.
Canada’s banking watchdog, Office of the Superintendent of Financial Institutions or OSFI, has proposed a number of measures beyond the existing mortgage stress test including loan-to-income and debt-to-income restrictions and debt-service coverage restrictions.
Currently the mortgage stress test puts the minimum qualifying rate for an uninsured mortgage at the greater of the contract rate plus two per cent, or 5.25 per cent.
“It’s going to be an interesting spring,” said Victor Tran, a RATESDOTCA mortgage expert. “If the BoC raises the overnight rate, we may see a slower housing market during the traditional spring housing rush than we are used to, as buyers wait for the market to bottom out before purchasing.
“However, the recent OSFI announcement could push more buyers into the market to purchase before they become unable to do so. Especially if it looks like the consultation will lead to changes in loan-to-income and debt-to-income ratios.”
Tran also predicts that if the Bank hikes the expected 25 bps and the variable-rate hits new highs the spring market may see a surge of investors forced to sell condos, possibly double the usual number.
That and a glut of new builds coming into the market in 2023 could bring condo prices down further.
A increase in mortgage fraud is also possible as people stretch to buy or renew a mortgage under the higher interest rates, he said.
If the Bank raises its rate by 25 basis points on Jan. 25 to 4.5 per cent, the prime rate of commercial banks will rise to 6.7 per cent.
RATESDOTCA says for every 25 bps increase a homeowner with a variable-rate mortgage can expect to pay about $14 more a month per $100,000 of mortgage.
Thus, a homeowner with a $500,000 mortgage at a rate of 5.25 per cent would see their rate rise to 5.50 per cent and payments increase $74 a month to $3,070, it said.
If this same homeowner had taken out their mortgage before March 2022, they would have seen a total increase to their mortgage payments of $1,129 a month since the Bank began hiking rates.
On a more hopeful note, BMO senior economist Robert Kavcic says mortgage rates should now be at or near their peak, if the Bank of Canada continues as expected.
If the Bank stops after a last 25 bps hike, the upward march of variable rates will end.
Meanwhile, a rally in government bonds has pulled 5-year yields in Canada — the basis for most long-term fixed mortgage rates — down to about 2.8 per cent, below the lows seen in December, said Kavcic.
These levels now look more consistent with 5-year fixed mortgage rates being in the 4.5 to 5 per cent range, he said, though it takes time for this to work through the system. (Currently 5-year fixed rates range from 4.39 to 6.49 per cent, according to mortgage comparison sites.)
“This is still a massive shock compared to readily available rates around 1.5 per cent just a year ago, but the stall in upward momentum should help at the margin, and offer some confidence that the worst of the rate shock is behind us,” wrote Kavcic.