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Bank of Canada Rate - Managing Expectations for the Announcement on December 7th

<strong>Bank of Canada Rate - Managing Expectations for the Announcement on December 7th</strong>

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As a result of Bank of Canada’s economic tightening, home prices have fallen an average of 18% in price from the start of their slowdown. What’s more notable, is that some regions in Canada have even more impacts on home prices and sales than others; for example, Toronto and Kitchen prices fell in the double digits from their highs in February while the impact was only in the single digits for Quebec City and Winnipeg. As our tight labour market continues to be stubborn with job vacancies throughout the country, it’s hard to make a case for the Bank of Canada to ease up on rate increases due to inflationary pressures. In this article, our goal is to show you how indicators have changed since the last rate increase at the end of October – as well as how expected BoC rate hikes could impact plans for your mortgage.


Key Takeaways

  • Labour market is still tight, but the housing market is entering a balanced territory
  • International pressures to Canada’s CPI are subsiding
  • Central Bankers continue rate hikes to avoid a double recession
  • Inverted Yield Curve in bond markets indicates recession likely for Canada and the World

Housing Prices Slide Due to Inflation

Housing prices are still sliding, but as buyers start to creep back into their mortgage journey, we’re seeing a reprieve back to a balanced market. The Canadian Real Estate Association (CREA) reports month-over-month home sale declines. Having slid further, Vancouver and GTA contributed to the decline as the biggest housing markets in the country. According to CREA, the national average home price is $644,000, down 9.9% year-over-year. Furthermore, as of last month, more urban markets in Ontario and BC have started to return to balanced territory measured by the Sales-to-New-Listings Ratio (SNLR).

No one truly knows when the rate hikes will last, but inflation just touched 7% for October on the last report that the Bank of Canada (BoC) rolled out in mid-November. We are still far from hitting the BoC’s goal of getting inflation under control as measured by the Consumer Price Index (CPI). The good news is that international pressures, such as supply chains outside the BoC’s control, are starting to ease.

The biggest challenge outside their control still facing the Bank of Canada is the labour market that remains stubbornly tight. The last straw needs to fall before we can curb the inflation issue. Global supply chain unclogging will have some impact on the labour market here at home as well. As more goods begin to flow, prices will have to drop to stay competitive. While the labour market was tight, companies that had increased prices to support higher wages and attract workers needed to ease up.

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Rate Hikes Haven’t Brought Inflation in Control

In similar past scenarios where the Bank of Canada had to fight inflation, they would increase rates until there was a drop in employment. Enough unemployment would curb inflation rapidly as the buying power of many would diminish with multiple rounds of layoffs. There are international forces at play that can help in the fight against inflation. Supply chains normalizing while demand from China wanes due to their homegrown property crisis and COVID zero lockdowns will amplify the effects of the supply stimulus. This “good news” could shield us from a rate hike much heftier than 25bps or 50bps (a basis point is one-hundredth of a percentage point) this time around on December 7th. 

The Bank of Canada forecasts inflation averaging 4.6% next year and not returning to the Bank’s target of 2% until the end of 2024, if possible. Industry experts and the financial markets are forecasting a 50bps increase. Currently, the Bank of Canada is holding the overnight rate at 3.75%; with another 50bps increase, it would reach 4.25%. Such an increase would make it 1700% higher than the 0.25% overnight rate, which was true only 9 months back in March when the BoC started its tightening.

Figure 1 – Canadian CPI Year-over-Year (% change) fluctuations between January 2019 (Pre-pandemic) to the present. Source Stats Canada

Zooming in on monthly fluctuations of the Canadian Consumer Price Index to illustrate the volatility of inflationary pressures during the same period.

Figure 2 – Canadian CPI Month-over-Month (% change) fluctuations between January 2019 (Pre-pandemic) to the present. Source Stats Canada

The incremental unemployment rate increases are insufficient to slow the tight labour market. However, many job banks are seeing a general change in job vacancies reduced by IT companies. The Bank of Canada is purporting that a possible slowing by reducing job vacancies could provide for a softer landing when Canada hits a recession. Rate increases may take some time to work through the economy.

Central Bankers Are Trying To Avoid A Double Recession

We’ve been brainwashed into thinking that today’s rates are nothing compared to what they paid in the 1970s and 1980s. Yes, some of our own parents may have had 18% interest payments back then despite their houses being priced at $100,000 on average! Keep in mind that the average income was $20,000. In those days, houses cost 5 times their income on average. Nowadays, homes cost almost a million dollars, and incomes still range around $100,000 if you’re lucky – otherwise, closer to $50,000 for most average Canadians. The cherry on top – they had 40-year amortizations, whereas we have only 25 years max unless you can come up with a 20% down payment. Moreover, back then, you could buy a home with zero down payment.

Most people in North America in the 1970s and 1980s will remember the consistently tight monetary policies of the Federal Reserve (the Fed in the US) and the Bank Of Canada (the BoC). As policy rates in Canada and US were cut in 1976, they erroneously thought that inflation had peaked; however, this turned out to be untrue as, by the beginning of the 1980s, they had to double rates overnight to prevent any more casualties from the inflation pressures.

Central bankers of the 1970s had a single overwhelming takeaway from that decade – don’t ease up on fighting inflation until you’re certain it has been defeated. When the Fed and the Bank of Canada cut their policy rates in 1976, they thought inflation had peaked. However, when this turned out to be untrue by the decade’s end, with prices rising at an increasingly faster rate than before, both institutions were forced into raising rates high enough to prevent any more damage from being done.Even though we are seeing the GDP trending lower, lagging inflation indicators such as unemployment, trade balance, consumer price index, corporate profits and labour costs are starting to see some declines. This experience, or the knowledge thereof, leaves them worried that the rate tightening hasn’t been effective enough until they see a big increase in unemployment alongside a big drop in the CPI.

Where the Fed and Bank of Canada are cautiously drawing conclusions: The 1970s showed inflation (illustrated below with the Canadian Consumer Price Index) can be volatile and persistent. Proclaiming success too soon on inflation after a temporary reprieve can result in an even bigger spike later.

Figure 3 – Canadian CPI Year-over-Year (% change) fluctuations between January 1970 and December 1985. Source Stats Canada

Zooming in on monthly fluctuations of the Canadian Consumer Price Index to illustrate the volatility of inflationary pressures during the same period.

Figure 4 – Canadian CPI Month-over-Month (% change) fluctuations between January 1970 and December 1985. Source Stats Canada

Even though we are seeing the GDP trending lower, lagging inflation indicators such as unemployment, trade balance, consumer price index, corporate profits and labour costs are starting to see some declines. This experience, or the knowledge thereof, leaves them worried that the rate tightening hasn’t been effective enough until they see a big increase in unemployment alongside a big drop in the CPI.

The Inverted Yield Curve: Recession Unavoidable for Canada

The bond market has been flashing red –The yield curve has been inverted more recently. What is a yield curve? A bond has an interest rate, also called a yield. The yield curve is like plotting the rate of interest that the government pays you on a bond over time. Bonds are bought and sold by bond traders as risk-free government debt on the capital market. The daily price is based on the anticipation of risk for the bond’s duration until maturity. Fixed-rate mortgages are priced based on these same bonds.

Typically longer-term bonds have higher yields as you take higher risk by holding them for longer. Generally speaking, the 10-year government (Government of Canada) bonds have a higher rate of return than the 2-year government bond. The 10-year bond is over 100bps (1%) below the 2-year bond. The bond yield curve has inverted, which has only happened a few previous times in recent history. The other two times that this happened were during the 1990s when we had a prolonged recession and once before when it was the Great Depression.

10-year U.S. Treasury yield minus two-year U.S. Treasury yield. This is the same yield curve pattern that occurs in the US before a recession. This time, the same pattern is showing up worldwide and in Canada’s bond market. Source: Globe & Mail St Louis Federal Reserve

Most times, the 10-year yield bond would be priced higher than the 2-year bond. This implies that it would be more of a risk for the lender (investor) to lend money to the borrower (government) for a longer period (over 10 years) than a shorter period (over 2 years), so the yield is expected to be higher for the longer term. Conversely, if the yields get reversed, the current and short-term situation for the government is not financially sound, so the rates are higher. However, as the 10-year bond is pricing lower, investors (lenders) believe that they expect the government to get their books in order within a longer period.

This time around, the inversion on the yield curve is deep, meaning that Canada is headed for a recession next year. Recession is not all bad news. It means that our economy will show negative numbers quickly once we hit a recession. These numbers would have to include a remarkable drop in employment – anywhere from 5% to 15% of the workforce being laid off. Once inflation is also under a manageable target – between 2% and 3% – the Bank of Canada will decide to reverse course. We need a recession to curb inflation domestically.

Labour Market and Supply Chain Adjusting to Inflation

Labour markets are starting to have fewer net vacancies as demand drops with inflation, and we will see more employers slow down or halt their pace of hiring. Many employers don’t want to lose talent or have to let go of staff and then spend even more money to hire again and re-train. These employers are hiring internally and optimizing their workforce for the coming recession. 

Yes, you read that right: A recession.It’s a tough word, and not everyone thinks of it similarly. The technical definition means two fiscal quarters of negative growth measured by the GDP. To some, recession means mass layoffs – and to others, it means lower wages or less work. But to everyone, it means the same thing – a time when the stock markets retract and financially things get a bit tougher for almost everyone. 

China is already in a recession, and their demand has reduced significantly in the past couple of months. With this additional increase in supply, we should expect to return to less tightness in the supply chain as more materials become available for manufacturing. Additionally, borrowing costs have increased so much since the start of the pandemic that more supply paired with a lack of domestic demand will likely easily slide us into a recession. That first rate increase by the Bank of Canada in March is now likely making its way through the economy.

Housing Supply Shortages Set Dire Expectations for Future Affordability

It’s been 70 years since the federal government set up the Canadian Mortgage Housing Corporation (CMHC) through the National Housing Act (NHA) to meet the housing demand created by the baby boom in post-war Canada. The NHA and CMHC were set up to introduce policy and financial instruments to make financing a home much easier for the average Canadian. However, since then, we have seen our population double, and the quality of immigrants coming with professional designations has remarkably increased in the last 20 years.

As China is seeing a real slowdown and the US is also set back by high inflation, the material supply will increase. Albeit, our borrowing capacity lags with short-term housing demand dwindling – leaving no appetite for housing even if there is much long-term need. In the last round, the Fed showed a more cautious approach than the Bank of Canada as they increased by a bigger chunk, relatively 75bps (0.75%) versus our 50bps (0.50%). We’ll soon see what path the central banks take this time around.

How Bank of Canada Rate Increases Affect Your Mortgage Payment and Qualifying Income

In this section, we have simplified numbers by tabulating average mortgage balances and their corresponding mortgage payment, stress-tested qualifying mortgage payment, and the qualifying gross annual income needed to support the mortgage balance. 

Each 25bps (0.25%) on a $100,000 balance equals $14 per month in a mortgage payment. This same mortgage payment change will require an additional $3400 annually in income to qualify for each similar increase.

Below are charts to help you conceptualize mortgage payments and qualifying income for each $100,000 balance with each 25 bps increase. Each increase by the central bank on its overnight rate will impact all lenders’ prime rates, including nesto’s.

Current Rate at 4.75%

Mortgage Amount Mortgage Payment Qualifying Payment Income Required
100000 567.46 685.05 41,201.83
200000 1,134.92 1,370.10 56,625.94
300000 1,702.38 2,055.15 76,081.71
400000 2,269.84 2,740.20 95,537.49
500000 2,837.30 3,425.25 114,993.26
600000 3,404.76 4,110.30 134,449.03
700000 3,972.22 4,795.35 153,904.80
800000 4,539.68 5,480.40 173,360.57
900000 5,107.14 6,165.45 192,816.34
1000000 5,674.60 6,850.50 212,272.11

Calculations are made with nesto’s mortgage payment calculator using current rates as advertised on our website. (as of November 28, 2022). Stress-tested qualification based on rate (4.75%) + 2% but mortgage payment based on actual contract rate (4.75%). Assumptions made: taxes are $5000 annually, heating is $100 monthly, 25yrs amortization, no condo fees and qualifying income inclusion of 35% (insurable GDSR criteria apply).

 If Rates Increase by 25bps to 5%

Mortgage Amount Mortgage Payment Qualifying Payment Income Required
100000 581.61 700.42 41,728.80
200000 1,163.22 1,400.84 57,596.23
300000 1,744.83 2,101.26 77,537.14
400000 2,326.44 2,801.68 97,478.06
500000 2,908.05 3,502.10 117,418.97
600000 3,489.66 4,202.52 137,359.89
700000 4,071.27 4,902.94 157,300.80
800000 4,652.88 5,603.36 177,241.71
900000 5,234.49 6,303.78 197,182.63
1000000 5,816.10 7,004.20 217,123.54
Calculations are made with nesto’s mortgage payment calculator using current rates as advertised on our website. (as of November 28, 2022). Stress-tested qualification based on rate (5%) + 2% but mortgage payment based on actual contract rate (5%). Assumptions made: taxes are $5000 annually, heating is $100 monthly, 25yrs amortization, no condo fees and qualifying income inclusion of 35% (insurable GDSR criteria apply).

If Rates Increase by 50bps to 5.25%

Mortgage Amount Mortgage Payment Qualifying Payment Income Required
100000 595.92 715.92 42,260.23
200000 1,191.84 1,431.84 58,577.49
300000 1,787.76 2,147.76 79,009.03
400000 2,383.68 2,863.68 99,440.57
500000 2,979.60 3,579.60 119,872.11
600000 3,575.52 4,295.52 140,303.66
700000 4,171.44 5,011.44 160,735.20
800000 4,767.36 5,727.36 181,166.74
900000 5,363.28 6,443.28 201,598.29
1000000 5,959.20 7,159.20 222,029.83
Calculations are made with nesto’s mortgage payment calculator using current rates as advertised on our website. (as of November 28, 2022). Stress-tested qualification based on rate (5.25%) + 2% but mortgage payment based on actual contract rate (5.25%). Assumptions made: taxes are $5000 annually, heating is $100 monthly, 25yrs amortization, no condo fees and qualifying income inclusion of 35% (insurable GDSR criteria apply).

If Rates Increase by 75bps to 5.50%

Mortgage Amount Mortgage Payment Qualifying Payment Income Required
100000 610.40 731.56 42,796.46
200000 1,220.80 1,463.12 59,570.40
300000 1,831.20 2,194.68 80,498.40
400000 2,441.60 2,926.24 101,426.40
500000 3,052.00 3,657.80 122,354.40
600000 3,662.40 4,389.36 143,282.40
700000 4,272.80 5,120.92 164,210.40
800000 4,883.20 5,852.48 185,138.40
900000 5,493.60 6,584.04 206,066.40
1000000 6,104.00 7,315.60 226,994.40
Calculations are made with nesto’s mortgage payment calculator using current rates as advertised on our website. (as of November 28, 2022). Stress-tested qualification based on rate (5.50%) + 2% but mortgage payment based on actual contract rate (5.50%). Assumptions made: taxes are $5000 annually, heating is $100 monthly, 25yrs amortization, no condo fees and qualifying income inclusion of 35% (insurable GDSR criteria apply).

If Rates Increase by 100bps to 5.75%

Mortgage Amount Mortgage Payment Qualifying Payment Income Required
100000 625.03 747.33 43,337.14
200000 1,250.06 1,494.66 60,573.60
300000 1,875.09 2,241.99 82,003.20
400000 2,500.12 2,989.32 103,432.80
500000 3,125.15 3,736.65 124,862.40
600000 3,750.18 4,483.98 146,292.00
700000 4,375.21 5,231.31 167,721.60
800000 5,000.24 5,978.64 189,151.20
900000 5,625.27 6,725.97 210,580.80
1000000 6,250.30 7,473.30 232,010.40
Calculations are made with nesto’s mortgage payment calculator using current rates as advertised on our website. (as of November 28, 2022). Stress-tested qualification based on rate (5.75%) + 2% but mortgage payment based on actual contract rate (5.75%). Assumptions made: taxes are $5000 annually, heating is $100 monthly, 25yrs amortization, no condo fees and qualifying income inclusion of 35% (insurable GDSR criteria apply).

If Rates Increase by 125bps to 6%

Mortgage Amount Mortgage Payment Qualifying Payment Income Required
100000 639.81 763.22 43,881.94
200000 1,279.62 1,526.44 61,587.09
300000 1,919.43 2,289.66 83,523.43
400000 2,559.24 3,052.88 105,459.77
500000 3,199.05 3,816.10 127,396.11
600000 3,838.86 4,579.32 149,332.46
700000 4,478.67 5,342.54 171,268.80
800000 5,118.48 6,105.76 193,205.14
900000 5,758.29 6,868.98 215,141.49
1000000 6,398.10 7,632.20 237,077.83

Calculations are made with nesto’s mortgage payment calculator using current rates as advertised on our website. (as of November 28, 2022). Stress-tested qualification based on rate (6%) + 2% but mortgage payment based on actual contract rate (6%). Assumptions made: taxes are $5000 annually, heating is $100 monthly, 25yrs amortization, no condo fees and qualifying income inclusion of 35% (insurable GDSR criteria apply).

 In the worst-case scenario of a 125bps increase, a client carrying a $100,000 balance would need an income boost of $2680 annually to qualify. For a $1 million balance, an increase in income of $24,806 annually would be needed to qualify. This worst-case scenario is quite unlikely as the Bank of Canada understands from experience that their rate increases take approximately 6 months to a year to fully impact or work through the economy. If they overestimate the amount of weight they add to the economy, it may struggle to get out of a recession when it finally gets to one.

Options For Your Variable Rate Mortgage During Inflation

So what can you do here? First, consider all your options: can you afford to carry a larger payment? Are you planning on keeping the home for a longer term? What is the cost assessment of renting versus homeownership? Do you expect to save money if you delay your purchase? Let’s look at these questions one at a time.

Early Renew Your Mortgage to Lock in Your Rate

If you can afford to carry a larger payment but prefer to have your sanity back, you could have the ability to early renew your variable rate to a fixed rate and lock in the payment for the next 3 to 5 years. Overall the rate may be lower than the current variable rates. Still, there is a chance that if the longer-term outlook is better than the shorter-term, variable rates may overtake fixed ones before inflation is tamed. If you have already purchased but qualified on a variable rate, then review with your lender to see if you can move forward with a fixed rate. Or, if qualifying is the issue, you can early renew to a fixed rate almost immediately after your closing, that is, once your mortgage is funded.

Extending Your Mortgage Term to Hedge Inflation

As discussed earlier, with the indication from the inverted yield curve, we’re likely to see rates drop in a year or two. So if you’re up for renewal, the best option is to look at shorter-term fixed rates to provide the stability you need. If your risk and preferences allow you to carry a variable-rate mortgage (with static payments), you’ll be the first to notice savings once rates turn around. If rates keep increasing, just beware of trigger rates that can creep up on your variable-rate mortgage (VRM). Without updating your payment, your VRM can quickly reach a trigger point if you’re carrying a default-insured mortgage. Your alternative option is to choose an adjustable-rate mortgage (ARM) where your payments fluctuate with your rate – such that trigger rates or trigger points do not impact you.

Renting While You Wait for Inflation to Settle Down

You can also compare the costs of renting versus ownership. Assuming that the average rent for a 1-bedroom apartment is $2000 across the country, you’re looking at $24,000 in annual rent. Will $24K cover your annual mortgage payments – probably not – but then again, you won’t build equity by renting. Once the inflationary pressure settles, homes will start rising again, so then you may have to translate any savings into a premium added to the increased cost to purchase your home. Higher rates may not last as long as it takes to build up savings for a downpayment. Therefore, if your financial situation allows you to buy now, I recommend locking in a rate and finding the perfect home.

Being able to delay your purchase to avoid higher rates and possibly buying for a lower value may sound like a good idea. This could help you save money if you get the timing right. If you get it wrong, the market will quickly revert to a seller’s market. What are the benefits of buying now? The biggest benefit is that it is a buyers’ market for the first time in a decade. You don’t have to give up anything. You can still place conditions and do your due diligence before buying one of your lifetime’s biggest investments. Previously you’d have had to waive your conditions, be in bidding wars and maybe even write a love letter to the seller before they even looked at your offer seriously. Now you can do whatever it takes to ensure you’re perfectly happy with your purchase. In this market, I have even heard of people putting a conditional purchase on 90 days to complete a firm sale of their home. Before 2022, this was almost unheard of unless you were an insider in the transaction or knew the seller well.

Home Prices Usually Don’t Go Down

In many ways, the stock market behaves similarly to the housing market – when the costs to borrow money go up, then the stimulus to invest goes down. Looking at the stock market, you’ll notice that the best-performing years are right after the worst-performing years. You’ll find a similar case with the housing market – both depend on the labour market. When employed with little or no risk of layoff, people are more likely to buy homes or stocks. The only difference is the price tag for a unit of a company’s stock versus the price of any home in Canada.

We expect a large influx of immigrants – especially as we see labour shortages that need positions to fill before the labour market can tighten further. We know the demand for housing already exists as housing affordability advocates have made it clear in many publications – even more so when the housing market was surging – increasingly highlighting the unaffordability factor. The vast majority of immigrants will settle in Southern Ontario and Lower BC. These regions will be quite welcoming as even more temperate climates as global warming escalates.

If you want to own a home in the next couple of years, this is the most suitable time for you! Prices are starting to reach lows not seen in 3 years and possibly could get lower after the next rate hike expected on December 7th. But be mindful that if you purchase after the rate hike, then your qualifying amount could be lower than what it is currently due to the requirement of stress-testing your mortgage payment on the possibly higher rate plus 2%. Like stocks, your home’s value will only go up once rates start coming down.

Final Thoughts

As the government increased its debt load over the pandemic, so did Canadians who are borrowing for mortgages on investments backed by government bonds. As the debt climbed, so did the interest rates as the risk to the lenders (bond investors) heightened. Recessions are a surety in life, just like death and taxes. The sooner they happen, the better the economy will be – unfortunately, the one that the government is trying to fight this time is extremely stubborn.

Once the recession occurs, it will heal many wounds – it may also make many more for borrowers who were not using caution or getting sound advice for their finances. If you’re looking for sound financial advice to reach your goal of homeownership, then reach out to one of nesto’s professionally qualified mortgage experts who will guide and advise you through the process of homeownership.


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