The Bank of Canada’s (BoC’s) prolonged tightening of economic activity over the last several months have seen Canadian home prices drop predictably, from an average of $749K to $612K year-over-year compared to last January. This 18.3% decline in home prices has been a cause for concern for many Canadians looking to buy or sell their homes. Despite the drop, experts predict that Canadian home prices could continue to fall by another 12% in 2023, making it difficult for many Canadians to afford a home. However, this may be good news for first-time buyers struggling to enter the housing market due to high prices.

In this article, we aim to provide an update on how economic indicators adjust from the BoC’s January 25th rate hike and its influence on the mortgage and housing market for the next rate decision expected on March 8th.

---

Key Takeaways

• Economists are in a 95% consensus that rates will remain unchanged on March 8th.
• Unemployment is falling while real wages fall due to inflation – a potential turnaround is imminent.
• Due to long-term demand, housing will stay unaffordable.

---

Housing Prices Slide Further Due to Inflation

Are you looking to buy a home in Canada? Despite the recent decline in housing prices, the good news is on the horizon. The Canadian Real Estate Association (CREA) has reported a visible reprieve back toward balance in the industry. This means that buyers are slowly re-entering the market, creating much-needed equilibrium. With this positive shift, now may be a great time to start your search for your dream home.

The Bank of Canada is slowly progressing in its mission to reign in inflation as measured by Consumer Price Index (CPI). The effects of inflation have been felt more quickly in the housing industry than in any other sector. However, other industries such as communications, energy, industrials and technology are also sensitive to interest rates and have started showing signs of slowing down. As interest rates increase, consumer carrying costs increase, curtailing more investment in these industries. Additionally, these industries rely on borrowed capital to invest in new projects, which affects their bottom line.

Industries that heavily rely on borrowed capital to fund new projects are feeling the impact of rising interest rates, which ultimately affects their profitability. It can take up to or more than a year for the full effects of these hikes to be felt throughout the economy. As a result, there is speculation that the Bank of Canada may pause its rate hikes to assess the impact of its monetary policy before making any further moves. While a rate reversal is expected, policymakers must be more certain about when it will happen. The question on everyone’s mind is: when will the Bank of Canada hit a pause on interest rate hikes?

Figure 1 – Changes in the YoY Average Residential Price Changes in Canada. Source: CREA

According to Nigel D’Souza, investment analyst at Veritas, the Canadian real estate market has not experienced significant selling pressure as many mortgage holders remain employed, and higher interest rates introduced by the Bank of Canada have yet to result in increased mortgage payments for a large number of people. He believes the greater risk lies in areas such as credit cards, auto loans, unsecured lines of credit, and commercial lending rather than in mortgages or residential real estate. 

The Canadian housing market is facing additional strain due to a record-setting influx of temporary residents, just as the construction industry is pulling back on new builds. According to recently published figures from Immigration, Refugees and Citizenship Canada, by the end of 2022, there were approximately 1.95 million people from abroad with temporary work or study permits in the country – an increase of about 560,000 (40 percent) over the previous year. The International Mobility Program accounted for slightly more than one million of those permits – a new high, up more than 300,000 in a year.

Canada`s population grew at its quickest pace in over 50 years during the third quarter of 2022, mostly because of the increase in temporary residents. Nevertheless, Statistics Canada noted that the spike in temporary residents over the past year was “driven” by people with work permits. Unfortunately, this surge in demand is putting pressure on an already strained housing market and has led to rising rents across many parts of Canada.

According to a report by Desjardins Securities published this week, residential home construction would need to increase immediately by 50% through the end of 2024 to support higher immigration targets and keep prices from climbing further. However, housing starts fell significantly in parts of Ontario with populations over 10,000 – down 31% to an annual rate of roughly 71,500 units. As such, it remains to be seen how Canada’s housing market will cope with this sudden increase in demand for accommodation and how policymakers will respond to these challenges.

Figure 2 – Temporary Work and Study Permit Holders in Thousands. The Globe & Mail, Source: IRCC

The Disconnect Between Inflation and Employment

Canada’s recent job creation figures have continued a prevailing trend in other developed economies. But as the economy cooled, inflation seemed to be the only constant in an otherwise uncertain backdrop. Hence why, when it surged last year, leading economists voiced concern that if interest rates were hiked too severely, everyone from businesses to everyday workers would face an immense burden – resulting in mass job losses and slowing demand even further. Worse still, these pleas were largely ignored as the Biden administration opted for sizeable stimulus packages to inject much-needed hope into the global economies – including Canada’s, as it is economically anchored to our southern neighbour.

The job market may seem healthy if you look at the headline figures, but insiders know the underlying problem: more jobs may exist, but wages aren’t rising faster than inflation. Employers are scrambling to fill open roles. But why does it appear that jobs aren’t cooling off demand? Economists don’t like accepting an answer they can’t measure, so their models get recalibrated. This time around, though – real wage data offers up some answers. While there may be plenty of job openings advertised in the marketplace – wages have yet to keep pace with inflation, and as such, employee earnings are shrinking – giving us more insight into this puzzle.

Staying true to its namesake sprinter – the Carl Lewis Effect explains that inflation last year had been left far behind by a fresh wave of wage growth. However, it may have taken some time for real wages to catch up initially, and they seem set now on a course toward positive growth. But if employment is not what is throttling demand in G7 economies, then one must question: what is? Indeed there seems to be an inverse relationship between increasing salaries and falling prices across the G7.

The voices of central bankers have been a near-unison chorus recently, claiming that rising asset prices like Canada’s housing bubble had no real effect on the economy and that workers should adjust their expectations for inflation. But data suggests this might be an incorrect conclusion – suddenly increasing interest rates may lower inflation and potentially squeeze owners more than employees in the process! Is it possible Central Bankers are doing something right even if they don’t quite understand why?

Rate Hikes Having Some Effects on Reducing Inflation

The Bank of Canada has historically used interest rate hikes as a financial tool to combat inflation by decreasing people’s purchasing power, leading to declining consumer spending. In the past, the Bank of Canada’s unyielding stance resulted in significant reductions in commodity prices during times of excessive inflation. Despite this approach, inflation remains high, hovering around 5.9% as of the end of January. 

External geopolitical forces can impact our financial future, such as China’s property crisis and reversal to their COVID lockdowns which had expectations of a surge in their demand for goods and petroleum. However, the expected turnaround for China’s economy has not come to pass, keeping the demand for petroleum low. Most of the inflationary pressures arise from surges in food and petroleum prices. 

 According to recent data, Canada’s inflation rate experienced a slight decrease in January 2023, dropping to 5.9% from the previous month’s rate of 6.3%. This can be attributed to the easing prices for cellular services and passenger vehicles. When volatile energy and food prices are excluded, the core inflation rate was 4.9% in January 2023, down from December 2022’s rate of 5.3%. While this decrease may relieve consumers, it is important to continue monitoring inflation rates and their impact on the economy.

Figure 3 – 12-month change in the Consumer Price Index (CPI) and CPI excluding food and energy. Source: Bank of Canada

Shelter costs rose 6.6% year-over-year in January, a slower rate than December’s increase of 7.0%. The housing market’s ongoing cooling has led to decelerating growth in other owned accommodation expenses (+1.1%) and homeowners’ replacement costs (+4.3%). However, the mortgage interest cost index increased faster year-over-year due to the higher interest rate environment. It increased by 21.2% in January, the largest increase since September 1982, following an 18.0% increase in December.

Figure 4 – Mortgage interest cost and rent continue to increase faster, as homeowners’ replacement cost and other owned accommodation expenses increase slower. Source: StatsCan

Tighter Monetary Policy Creating A Tighter Job Market

Over the past year, many central banks in developed countries, including the Bank of Canada and the U.S. Federal Reserve, have implemented aggressive interest rate hikes, which could take up to 18 months to impact their economies fully. A tighter monetary policy, often implemented by a central bank to combat inflation, can lead to an expected reduction in employment. This is because higher interest rates make borrowing more expensive, leading to reduced consumer spending and decreased business investment. Companies may need to cut costs and reduce their workforce to maintain profitability. Additionally, tighter monetary policy can discourage new businesses from starting up or expanding due to the increased cost of borrowing. While tighter monetary policy can effectively reduce inflationary pressures, it often comes at the cost of higher unemployment rates and slower economic growth.

Inflation has spiked over the past few years, causing company profit margins to swell. However, if current trends continue, central bankers may need to impose even higher interest rates to combat inflation. Despite this, some experts argue that growth may reaccelerate over the coming year while inflation and interest rates remain high. Eric Lascelles, the chief economist at RBC Global Asset Management, points out that higher interest rates are necessary to tame today’s still-lofty inflation. However, others argue that central banks are deliberately causing recession by overtightening policy to combat inflation. 

An increase in transportation, communication, and banking technology advancement made it easier for companies to offshore their labour, making wages trend downwards. The COVID pandemic and Russia’s ongoing war on Ukraine affect our global trade. Additionally, making India and China turn inward, thus giving rise to more demand by western workers for higher wages – comes at an increased cost of production. Despite the economy slowing – wages are still rising. 

The Canadian labour force has continued to expand, with an additional 153,000 people joining in January, representing a 0.7% increase and pushing the participation rate up by 0.3 percentage points to 65.7%. The participation rate had recovered to its pre-pandemic level of 65.9% in September 2021 before slightly declining to 65.3% in June 2022. However, from July 2022 to January 2023, the labour force grew significantly, increasing by 336,000 individuals or 1.6%, which outpaced population growth during this period.

Figure 5 – Employment on upward trend since September. Source: StatsCan

The rise in labour force participation was observed across nearly all major demographic groups over the past few months, particularly among core-aged women and those aged between 55 and 64. This growth is a positive sign for Canada’s economy as it suggests that more people are seeking employment opportunities and contributing to economic growth. As the labour market continues to recover from pandemic-related disruptions, it will be interesting to see if this trend of increased participation will continue in the coming months.

Mohamed El-Erian, economist and former money manager who now serves as president of Queen’s College at the University of Cambridge, believes there is only a 25% chance of a painless soft landing for the economy. Equally likely is a scenario in which inflation takes off again this year as China fully reopens its economy and U.S. labour shortages persist. 

Consumer Confidence and Inflation Move in Opposite Direction

Consumer confidence in Canada has risen to its highest level since September. More Canadians see real estate values rebounding after the central bank conditionally halted its interest-rate hikes. The Bloomberg Nanos Canadian Confidence Index, which measures sentiment based on weekly polling, jumped by the most since the end of November. The index climbed to 47 on Friday, up from 45.7 a week earlier and 45.3 on Jan. 20, shortly before the Bank of Canada announced that it would stop increasing interest rates and hold its benchmark overnight rate steady at 4.5%. These improvements in sentiment suggest that there is an expectation of an imminent recovery in Canada’s housing market.

The Canadian housing market saw benchmark real estate prices drop by 15% from last year’s peak due to higher rates squeezing buyers. However, more than a quarter of respondents expect prices to rise in the next six months, the highest proportion since September but still below historical averages. Nik Nanos, the chief data scientist of Nanos Research, notes that views on real estate have consistently been a foundational element in consumer confidence. Although not returning to exuberant levels from a year ago when the housing market was red hot, weekly tracking is seeing the beginnings of a potential positive trajectory.

Every week, Nanos Research surveys 250 Canadians for their views on personal finances, job security, the economy and real-estate prices as part of its index measuring consumer confidence levels. The jump in consumer confidence is another indication of a sustained rebound for Canadian consumers at the start of 2023.

GDP Stays Flat As Inflation Does the Heavy Lifting

In the fourth quarter, real gross domestic product (GDP) remained almost unchanged, marking the end of five consecutive quarterly increases. This was due to slower inventory accumulations and declining business investments in machinery, equipment and housing. However, higher household and government spending and improved net trade partially offset these decreases.

On the other hand, domestic demand increased by 0.3% in the fourth quarter after declining by 0.2% in the previous quarter. Real GDP and final domestic demand rose for the second consecutive year annually following a contraction induced by the COVID-19 pandemic in 2020.

Figure 6 – Real gross domestic product and final domestic demand. Source: StatsCan

We’ve got robust job markets, consumption is holding up, the GDP is better in the details, and it’s just a distorted headline. Even if GDP edged down in February and March, the strong gain in January implies that first-quarter growth would still be marginally positive.

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 payments, and the qualifying gross annual income needed to support the mortgage balance. 

There is a 95% consensus amongst economists that the Bank of Canada will keep rates unchanged on March 8th. Rates are expected to stay paused until sometime in the fall. If inflation does not come down to the Bank’s target between 2% and 3%, it may increase rates once more at the end of 2023 before a change in trajectory.

Each 25bps (0.25%) on a $100,000 balance equals $14 monthly 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 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

If Rates Increase by 25bps 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

If Rates Increase by 50bps 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

Options For Your Variable Rate Mortgage During Inflation

What are your options if you’re having trouble managing your mortgage payment? First, consider all your options: can you afford 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. The variable rates have already overtaken fixed rates even before inflation is tamed. If you have already purchased but qualified on a variable rate, 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 in our previous thought leadership blog, 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 realize 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 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 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. It 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. You have the upper hand in this market as a buyer.

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 pleased 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 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 borrowing money costs go up, 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 had 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 in the future will be even more welcoming as global warming brings shorter winters.

If you want to own a home in the next couple of years, this is the most suitable time for you! Comparatively, prices are starting to reach lows not seen in 30 years and possibly could get lower after the next rate announcement expected on March 8th. But be mindful that if you purchase after the announcement, 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 increase once rates drop.

Final Thoughts

As the Bank of Canada carefully positions itself for economic stability, it’s important to ensure you optimize your mortgage’s stability and the best rate. Uncertainties hover over the real estate and mortgage markets, so it is wise to be proactive when deciding about your home financing. With housing price uncertainty in many areas of the country, now is the time to start having thoughtful discussions about mortgages. 

Speak with nesto’s knowledgeable mortgage experts, who can guide you through this challenging time and process. We are here to help you with upcoming changes affecting your bottom line. If you’re looking for assurances about the right mortgage solution for your needs, reach out – we would love to hear from you!

---