Canada’s central bank has hiked its key overnight rate by 425bps (1 basis point equals 1 hundredth of 1%) to 4.50% since March 2022 and warned of further increases. Rates could rise again after data showed the economy was hotter than predicted. Money markets show a 75% chance of a 25bps hike by the end of summer, with odds of a hike currently at 38% for next week’s policy meeting.

Economic resilience hampers the central bank’s attempts to control inflation, and its pause on rate hikes in January may end following recent data. Several analysts assert that the annual inflation rate’s slight increase in April could push the central bank to increase rates, particularly if inflation doesn’t slow as intended.

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Key Takeaways

• Recent increases in inflation and other economic factors are adding to the likelihood of a rate hike.
• Market expectations of a 25bps rate hike in July are higher than in June.
• Rate hikes and the labour market may not be the only pressures behind the recent uptick in inflation.

🚨Outcome [6/7]: Bank of Canada Has Increased Its Policy Rate 0.25%

• As the central bank takes measures to manage inflation, it may result in higher borrowing costs and a slowdown in residential construction.
• Concerns about a housing shortage and rising home prices persist.
• Economists are divided on the timing of a possible recession, but a soft landing is still feasible if the labour market remains robust.
• Consumer spending continues to drive inflationary pressure, potentially fuelling further interest rate hikes.
• The rising demand for rental homes and housing expenses are also contributing factors.
• Homebuyers and homeowners have various options to navigate the current economic landscape, such as early renewals, extending mortgage terms, or renting while waiting to buy.

Canada’s Strong Labour Market Is Keeping Inflation Elevated

Canada’s job market remains robust despite the Bank of Canada’s rate hikes, which aim to meet its 2% inflation target by increasing unemployment. However, inflation is falling even as the labour market strengthens. Economists say significant job losses, which often coincide with drops in inflation, are unlikely necessary for prices to decline. Nevertheless, the macroeconomic question of 2023 is whether this time is different.

Canada’s labour market held firm in April, according to the latest jobs report from Statistics Canada. Unemployment was steady at 5%, and the number of jobs created exceeded expectations. Meanwhile, inflation has steadily declined from its last June high of 8.1% to 4.3%. Global and non-labour-related factors, such as the close connection with the US economy, are at play. Concerns of a “wage-price spiral” that fed inflation in the 1970s are not applicable now, but the question is whether inflation can ease while unemployment stays low.

The latest jobs report indicates strong wage growth, with interest rates higher than inflation. Despite a fall in job vacancies, there is still an opportunity for workers’ wages to catch up after a few years of lagging. However, the potential impact of wage gains on economic conditions remains unclear. 

Experts predict that wage gains may not disrupt corporate profits and that a few years of sustained wage gains are possible without harming the economy. The Bank of Canada’s monetary policy approach may shift based on this trend. While the labour market has been strong, interest rate increases may take a long time to reflect in job data. There is some hope for a soft landing regarding recent events. However, it is essential to exercise caution and not be too optimistic.

Canada’s Labour Shortage Is Subjective

Companies are adapting to falling unemployment by incorporating innovations into their operations. However, many business groups prefer to press for increases in cheap labour instead of adapting. Despite claims of widespread labour shortages, Statistics Canada’s report shows only a few shortages for positions requiring at least a bachelor’s degree. On the other hand, there are many vacancies for lower-skilled jobs, where wages have not kept up with inflation. The rise in temporary foreign workers who accept cut wages contributes to the labour shortage. Businesses complain about a labour shortage but don’t invest in resolving the issue.

Economist Jim Stanford flags deeper structural issues in job vacancies: electronic job postings and low pay that lead to high turnover. Employers anticipating turnovers and vacancies are duplicating listings, which doesn’t indicate a genuine labour shortage. While some employers struggle, temporary foreign workers subsidize labour costs and productivity. 

Canadian consumers are helping to stimulate our economy’s growth by spending more on goods and services, with first-quarter growth in GDP driven by export and consumer spending sectors. The rise in consumer spending was unexpectedly high and pushed its share of GDP to the highest level since 1961, outpacing consumer spending in the US. This shopping spree risks the Bank of Canada’s efforts to curb inflation by damping demand. Some economists believe that the shopping frenzy raises the probability of another rate hike.

Labour Shortages Driving Higher Borrowing Costs

Exports and consumer spending drove GDP growth in Q1, which rose 5.7% year-over-year. Unfortunately, residential construction is slowing due to labour shortages and higher borrowing costs. Slowing construction during a housing shortage is problematic for the Bank of Canada and Canadians, as the government aims to increase housing affordability and welcome 500,000 immigrants annually. Housing starts are expected to fall to 212,000 in 2023 from 262,000 in 2022, limiting the ability to keep up with immigration.

Concerns have grown in Canada regarding the effect of residential real estate investors on housing. While providing necessary rental stock, they have also contributed to house price instability and limited market access for first-time homebuyers, according to StatCan.

A shortage of residential properties in Canada, along with increased immigration, is likely to drive house prices even higher. Since the start of 2021, average home prices have risen by 17%. 

Builders and developers complain that construction has slowed due to environmental opposition to building projects and resistance to plans for increased urban density. These obstacles and higher mortgage rates make purchasing a home even more challenging for the average Canadian.

Economists’ Expectations For Rate Hike Next Week

Money markets predict another Bank of Canada rate hike this year following stronger-than-expected GDP data. Analysts forecast Q1 annualized growth of 2.5% and a decline of 0.1% in March, but the economy grew at an annualized rate of 3.1%, exceeding expectations. 

We have summarized economists’ reactions to the robust May GDP numbers. A majority, 3 out of 5, expect the BoC to hike the nation’s benchmark target to the key overnight policy rate. 

Royce Mendes Desjardins Securities	Canadian consumers spent heavily in Q1, driving 3.1% annual growth in GDP, beating expectations and possibly signalling interest rates aren’t high enough. Q2 is also starting strong after a 0.2% GDP increase in April. The Bank of Canada may raise rates soon.
Stephen Brown Deputy Chief North American Economist Capital Economics	The 3.1% increase in first-quarter GDP surpasses estimates and strengthens the case for a Bank of Canada interest rate hike. Government and residential investments fell but were offset by a surge in consumption growth and business machinery investment.  Additionally, preliminary estimates suggest that April’s GDP increased by 0.2% month-over-month. This positive trend may lead to growth beyond the bank’s quarter forecast of 1.0% annualized. Overall, inflation and GDP performance exceed Bank expectations, supporting a rate hike next week.
Andrew Grantham Economist  CIBC Capital Markets	The headline reading, growth composition, and Q2 handoff were slightly more robust than anticipated, increasing the likelihood of another Bank of Canada rate hike. Nonetheless, they will probably wait to review additional data and adjust their forecasts in July’s Monetary Policy Report before reaching a conclusive decision on another rate hike instead of doing so next week.
James Orlando Director and Senior Economist TD	The Bank of Canada will announce the interest rate decision next week. Today’s report doesn’t affect the rate but could be used to raise rates later this summer. The BoC predicts a fast decline in economic growth over the remainder of the year, but if hot data persists, they may raise the rate again.
Douglas Porter Chief economist BMO Capital Economics	Today’s report had some big news, with flash estimates that April’s GDP has come in at 0.2% higher despite the public sector strike in the latter half of that month. Despite the strike’s slight impact on growth, the economy has more momentum than anticipated. As a result, our Q2 GDP forecast will be revised from an initial drop of -0.5% absolute risk to a slight positive.  These more substantial figures for Q1, March and April GDPs undoubtedly increase the odds that the Bank of Canada needs to hike rates and even put a chance on a move as early as next week’s policy decision. However, given the uncertain backdrop and the possibility that inflation has decreased significantly in May, the Bank of Canada could stay patient for longer and signal that they’re open to hiking in July if the strength persists.

Recession Forecasted But Timing Uncertain

Canada’s economy is more robust than predicted, even though high inflation and interest rates have pressured it. Earlier predictions of a 2023 recession may have been premature, given stronger-than-expected GDP figures and other economic growth factors. Some economists, including the Royal Bank of Canada and Bank of Montreal, have revised their earlier bleak predictions, with forecasts for a recession now looking less likely. However, economists still believe that the broad economy will experience some dips later in the year due to hefty interest rate hikes by the Bank of Canada.

Economists indicate a high likelihood of a 2024 recession, with a 60% chance in 2023. RSM warns that residential, commercial real estate, retail and energy will suffer the most, possibly impacting the Canadian economy. 

The lower-earning population will face the brunt of it, and some Canadians already struggle with higher interest rates and living costs. However, a soft landing is possible if the labour market remains strong.

More than expected, the Canadian economy grew by 3.1% in Q1, prompting rate hike speculation. Growth rose due to exports and consumer spending, and a preliminary Statistics Canada estimate shows the momentum continuing into April. 

Exports were up 2.4%, mainly driven by passenger vehicles, metals and agricultural products. Economic weaknesses were present, with a 3.9% decline in housing investment and a 2.5% reduction in business investment in machinery. 

Bank of Canada and Bay Street predict a slowdown for the remainder of 2023, with a mild recession as higher mortgage rates impact real estate activity. Soft-landing is predicted when inflation reaches a 2% target over time without significant economic contraction or unemployment. In Q1, household income was down 1%, and employee compensation was up 1.7%, offset by decreased government transfers.

Too Much Of A Good Thing

Consumer spending is driving more inflationary pressure in the quarter, not less, suggesting that the central bank’s battle against inflation still needs to be won. With household consumption up nearly 6% annualized in Q1, some economists suggest further interest rate hikes to tame consumer demand feeding inflation pressures. However, Statscan’s figures for March and April point to a waning of consumer appetites, suggesting a much slower economy is coming.

According to recent reports from the Canadian Chamber of Commerce and the Conference Board of Canada, Canadian consumer spending per capita and business investment are declining. The latter warns of waning consumer confidence as high household debt, high-interest rates, and falling home values take their toll. Retail and spending figures suggest these warnings may come to pass.

The Bank of Canada warns that sustained economic growth could fuel inflation, indicating higher interest rates may be necessary to cool demand. Rapid population growth, led by immigration, drives strong labour capacity and consumer demand, increasing GDP and raising the ceiling on growth potential. If the GDP exceeds the bank’s outlook, it may increase interest rates to reduce inflation risks.

Rents Not Interest Rates Driving Up Inflation

BMO senior economist Robert Kavcic says rate hikes aren’t inflationary despite the rising demand for rental homes and housing expenses’ effects on inflation and essential issues. April’s 4.4% year-over-year inflation rate was mainly caused by slightly less than 30% of the consumer price index (CPI) basket, which includes shelter expenses. Within that category are four significant housing aspects: replacement cost, other owned accommodation expenditures, mortgage expenses, and rent. 

Due to the changes in the housing market and interest rates, home costs and real estate fees are adjusting much faster and were deflationary overall in April, which lowered the annual CPI by about 0.2%.

Mortgage interest expenses and market interest rate fluctuations influenced April’s headline inflation. StatCan examined property price changes and market interest rate differences to form the interest cost burden. Rent is the last shelter cost component, and rent prices gradually affect the official inflation index. 

Housing expenses had an 8.1% year-over-year increase and a 2.4% increase in headline CPI. Increased demand for housing may be driving inflation higher. The Canadian population has risen significantly, and the rental market has shifted.

Options For Homeowners and Homebuyers

Homebuyers and homeowners have several options available to them in the current economy. Early renewals are viable for those wanting to lock in a mortgage rate before anticipated rate hikes. Extending your mortgage term can help you hedge against inflation and could lower your payments. 

If you’re still deciding whether to buy a home, renting could be wise while you wait for inflation to settle down. While home prices may be low right now, it’s important to remember that they likely won’t stay that way for long. By staying informed on market trends and exploring all your options for refinancing or buying, you can make the best decision for your financial situation. 

Overall, it’s an ever-evolving landscape and keeping an eye on factors like GDP and inflation can help ensure you’re making the most of your mortgage.

Early Renew Your Mortgage

Consider early renewing your variable-rate mortgage to a fixed rate to stabilize your payment over the next 3 to 5 years and potentially reduce your monthly payment.  Talk to your lender about your early renewal or refinancing option to a fixed rate. As a first-time homebuyer, if qualification is an issue, close your mortgage and renew or refinance to a fixed rate immediately.

Extending Your Mortgage Term

For a long-term home investment, consider early renewing to increase your mortgage term to avoid renewing during a prolonged period of uncertainty. Choose between fixed and variable depending on your preference and risk. 

Consider making prepayments on your variable-rate mortgage. Alternatively, opt for an adjustable-rate mortgage or a shorter fixed rate to avoid hitting your trigger point during the current economic uncertainty.

Renting While You Wait To Buy

Compare renting versus owning costs, where annual rent of $36,000 (based on $3,000 average monthly rent in Canada in May) won’t cover mortgage payments, albeit renting doesn’t build equity. Inflation will increase home prices, so buy if your finances allow. By waiting on the sidelines, you risk missing out and could face an even more restrictive housing market.

Home Prices Are Only Headed Up

Rising prices in Canada’s housing market are inevitable due to high demand and low housing supply. Regardless of the Feds curbing its immigration targets, Canada remains an attractive place to resettle. Our natural resources, political stability, and climate all add to the overall value that Canada offers newcomers. 

The demand for housing will only grow while supply continues to wane. And as global warming worsens over the next few decades, Canada will become a popular destination for climate refugees in addition to immigrants, further adding to housing demand in this country. The continuing demand for housing will keep driving up its cost and labour, making them valuable commodities.

Final Thoughts

Buying a home is worth consideration because it is a tangible asset that will appreciate over time. There’s no perfect time to buy, so base your decision on your short and long-term goals and financial situation. Regardless of current market conditions, it’s always better to buy now. Reach out to nesto’s commission-free mortgage experts to help guide you through the homebuying process.

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