The Bank of Canada (BoC) held its policy rate steady last week, as was widely expected.
The surprise, at least to this blogger, was the decidedly hawkish tone in the Bank’s accompanying communications.
The BoC continued to acknowledge both the upside inflation risks tied to spiking energy prices and the downside risks tied to the escalating US trade war, but it placed much more emphasis on the former.
It observed a “broad-based” pick up in our domestic economy, with “solid gains” in consumption, “some rebound” in housing activity, and a sharp rise in exports and business investment. Overall, the Bank assessed that our economic rebound was “broadening”.
The BoC noted “persistently higher gasoline prices” and warned that “the longer high oil prices and elevated refinery margins persist, the greater the risk of spillover to the prices of other goods and services”. It sees “little progress on the reopening of the Strait of Hormuz” and warned that “US tariffs and Canadian counter-tariffs will also raise costs for some businesses and could feed into consumer prices over time”.
The Bank warned (twice) in its policy statement that “the upside risks to inflation have increased”. That kind of emphasis gets the market’s attention. Mortgage columnist Rob McLister likened the Bank’s hawkish rate-hike language to BoC Governor Macklem “doing warm-up stretches”.
Bond market investors are now pricing in a 100% chance of a 0.25% hike by the BoC at its meeting on December 9, and three more 0.25% hikes in 2027.
Last week’s BoC update will likely push a lot of mortgage borrowers who are sitting on the fixed/variable fence toward fixed-rate options, and I certainly won’t try to persuade anyone to choose differently in the current environment. But I will also humbly register my doubt that the rate hikes currently being priced in by the bond market will ultimately materialize.
Let me start by pointing out that the bond market’s estimates of future BoC rate hikes have been all over the place this year, ranging from four imminent 0.25% hikes, down to one hike, and then back to four hikes again. That’s not exactly high-conviction forecasting.
If you’re looking for reasons to doubt the consensus forecast, consider that a sustained inflation run-up is unlikely to take hold without a corresponding rise in average wages – and average wage growth is slowing.
Average year-over-year wage growth fell 2% last month, its lowest level since November 2017, well below our current inflation rate (3%). When prices increase faster than wages, households lose purchasing power. That forces them to reduce consumption and puts a squeeze on profit margins (with a disinflationary result).
A strong GDP rebound in Q2 was a welcome surprise after two quarters of stall-speed growth. But Statistics Canada recently estimated that our economy did not expand, meaning we didn’t carry any of that momentum into Q3. It also confirmed that our economy lost 42,000 jobs in August.
Our recently weakening economic data do not yet incorporate any impact from the latest round of US tariffs and Canadian counter-tariffs, or from tightening financial conditions caused by rising global bond yields. (Reminder: rising bond yields create demand-curtailing impacts similar to those caused by central bank rate hikes.)
The BoC sees those risks.
It noted that “labour demand remains subdued” and that its indicators point to “continued excess supply in the economy”. It also acknowledged that “new tariffs make growth prospects more uncertain”.
On balance, the Bank now believes that upside inflation risks have increased, but it also notes that there is “little evidence” thus far of higher energy prices leading to more generalized inflation. Consider that while our headline Consumer Price Index (CPI) stands at 3%, our most closely watched gauges of core inflation are still bang on the Bank’s 2% target.
I have no doubt that the BoC’s too-slow response to our post-COVID inflation run up gives it an itchier trigger finger this time around. But in these uncertain times, inflation risk remains two-sided, so there is still a difference between Governor Macklem doing warm-up stretches and pulling the rate-hike lever.
If the recent weakening trends in our economic data continue, which appears likely, the BoC may well be sounding like a different bird at its next meeting on October 19 (with the bond market re-adjusting its rate-hike bets accordingly).
The Latest on Mortgage Rates
Government of Canada (GoC) bond yields moved higher last Wednesday following the BoC’s policy-rate announcement, although only a little, and with some retracement on Friday after our weaker-then-expected employment data were released.
We are in the midst of a slow grind higher in global rise in longer-term bond yields. If that trend continues, it will exert upward pressure on our fixed mortgage rates over the near term.
Variable-rate discounts were unchanged last week.
As outlined above, the bond-market is now pricing in four 0.25% rate hikes by the BoC over the next year, with the first hike to take place at the BoC’s meeting on December 9.
I am maintaining my out-of-consensus call that the Bank is more likely to remain on hold (or even cut) over that same period, for the reasons outlined above.
My Take on Today’s Mortgage Options
I appreciate the appeal of fixed-rate stability in our current volatile environment. Many of the borrowers I work with today are choosing fixed rates, and I’m not trying to talk anyone out of those options. I appreciate the value of certainty in an increasingly uncertain world even if it comes at higher cost.
When asked for my view on whether a fixed or variable rate is more likely to prove cheaper, I maintain my view that today’s variable rates have the best chance to save borrowers money over their full terms – an admittedly contrarian call right now.
Variable mortgage rates are holding steady, but the backdrop that is holding them in place is anything but stable. For now, two competing risks are roughly offsetting each other: 1) The upside risk that spiking energy prices will lead to generalized inflation, and 2) the downside risk that the US/Canada trade war will disrupt our economy and cause disinflation.
Simply put, I expect the disinflationary impacts from trade uncertainty to last longer than the inflationary impacts from higher energy prices.
Important note: Anyone choosing a variable rate should do so only if they are comfortable with its inherent potential for volatility. Borrowers must have the financial capacity to withstand higher costs and, in some cases, higher payments.
That said, it is also important to note that fixed rates also come with risk. If bond yields rise sharply in anticipation of higher inflation and that inflation doesn’t materialize, anyone who locked in a fixed rate during the run up will be paying that associated premium regardless.
(On a related note, here is a link to my interview last week with Erica Alini at the Globe & Mail discussing What the trade war and U.S. policy mean for Canadian mortgage rates.)
Insider’s Tip for Borrowers
Does the payment frequency you choose for your mortgage have a material impact on your borrowing cost over time?
The correct answer might surprise you.
Three Posts Every New Visitor to My Blog Should Read:
1. Should Canadians Choose a Fixed or Variable Mortgage Rate During a Trade War?
This post provides a detailed comparison of the pros and cons of fixed- and variable-rate mortgages amidst trade-related economic uncertainty.
2. What Every Canadian Borrower Needs to Know About Fixed-Rate Mortgage Penalties
For myriad reasons, some of them unanticipated, many Canadians end up having to break their fixed-rate mortgages. This post provides a detailed explanation of the very different ways that lenders calculate their fixed-rate mortgage penalties. The amounts charged can vary significantly from lender to lender.
This post provides a detailed summary of the key terms and conditions to pay attention to in your mortgage contract. (They are not standard and can vary in important ways.)
David Larock is an independent full-time mortgage broker and industry insider who works with Canadian borrowers from coast to coast. David's posts appear on Mondays on this blog, Move Smartly, and on his blog, Integrated Mortgage Planners/blog.