Canadian mortgage borrowers waiting on the central bank may be disappointed by its latest move. The Bank of Canada (BoC) cut its overnight rate by 0.25 points to 2.75% on Tuesday. Many professionals applauded the decision, believing it would improve mortgage affordability. Unfortunately, that may not be the case, as the decision boosted inflation expectations and sent bond yields higher. This ultimately applies upward pressure on popular fixed-rate products, raising the floor of borrowing costs.
Bank of Canada Rate Cuts Influence Variable Rate Mortgages
Most people hear rate cuts and think that means cheaper mortgages, but that’s not always the case. The overnight rate only impacts short-term borrowing costs, such as variable-rate mortgages. Those reflected the 0.25-point cut immediately, with the lowest nationally advertised rate falling to 4.25% right after. However, variable-rate mortgages are historically a small part of the market and were only briefly popular during the low-rate pandemic frenzy.
Canadians traditionally prefer the stability of a 5-year fixed-rate mortgage. The cost isn’t based on the overnight rate, but bond yields—the Government of Canada (GoC) 5-year bond yield, to be exact. Credit is competitive, so lenders compete with this bond by offering investors a slightly higher yield.
Since the rate cut, the GoC 5-year bond yield has been climbing higher. The yield closed at 2.629% on Monday, and closed a little over a basis point higher after the Tuesday announcement. As of writing, the yield climbed to 2.673%, up 4.4 basis points.
That may not seem like a lot, but let’s assume it trickles down to a homebuyer of a $1 million property with 20% down. Rather than getting the post-rate cut discount they anticipated, they’ll pay $2k more over the term. It’s not exactly earth-shattering, but an average household will work an extra week to pay it off. Not the relief they anticipated, and it has only been a week. Each rate decision takes 18 to 24 months to impact a market fully. What gives?
Bank of Canada Repeats Pandemic-Era Mistake of Disregarding Data
Investor expectations influence bond yields, with inflation playing a big part. Investors are generally not in the business of losing money, so they factor inflation into their returns. As inflation expectations rise, so do bond yields to keep investors interested.
The BoC is a single-mandate central bank, and that mandate is inflation targeting. Its primary tool is interest rates to maintain its 2-point target, plus or minus a point of tolerance. When the rate falls too low, it slashes rates to stimulate borrowing and demand, hoping to drive inflation. When inflation is too high, it raises rates to slow demand and lower inflation. Simple enough, right?
When the BoC cut rates this week, it also did so while expecting a big jump in inflation. The GST/HST Tax Holiday was temporarily suppressing CPI, and concealing an increase. The central bank explained it expects the rate to rise as the effect of the Holiday is removed in February. As we noted earlier, there’s a good chance that CPI breaks the upper tolerance band. If this happens, the central bank may be forced to raise rates to throttle credit.
Typically a central bank wouldn’t cut at this point, as the country’s largest bank expected. The BoC decided to disregard its mandate and act on the emotional fear of the impact of the trade war tariffs. It disregarded its data-driven approach in favor of fear, which is something an amateur investor does, not a central bank.
The mistake echoes the ones made during the pandemic, leaving central banks with an inflation crisis. Rather than being data dependent, they felt the data was wrong and deferred to the gut instinct of policymakers. Most people still think inflation was a global crisis, but the BIS argues that central banks around the world just made the same mistakes, which is very different.
Rather than delivering cheaper mortgage credit, the central bank may have just raised the floor on borrowing costs. Good grief.
The irony is that bond yields were falling before the bone-headed cut. Big Six all just made a cut last week on the assumption the BoC was holding rates.
The issue is there has been not much demand for treasury bonds since Feb 2022. It is the reason American fixed mortgage interest rates are not going down as well. Root cause – impending dedollarization/deglobalization which led to tariffs and cost cutting.
Tiff can ignore the market but it’s going to still do its thing. He’s going to be forced into buying these bonds to control his own incompetence.
He should have cut more aggressively, with a lower dollar it might have offset US tariffs, made Canadian products cheaper, inflation is overplayed sadly. People are losing their jobs, reducing their consumption to needs, without demand there will be stagflation to counteract prices. Yields are priced against what the BoC offers as a lending rate
Weren’t inflation and interest rates historically low for a significant period of time leading up to the pandemic? Seems like the data to support the idea that inflation and interest rates positively correlated is very weak. Japan is the obvious example.
Keynesian economics predicts that when interest rates reach the zero lower bound without stimulating inflation, the system has broken down – low rates won’t stimulate inflation, and you can basically print massive amounts of money without it leading to hyper inflation, although there was a thought it might lead to some inflation (more or less the basis of QE). This led to the last decade of QE as welfare for billionaires – effectively free money to buy up all productive assets in the world, while the poors maybe could borrow a little more to afford a slightly nicer house (until the price of every asset including houses inflated out of the poors’ reach…). If the money printed has been given to poor people instead of billionaires, they probably would have spent it on things like improving nutrition and education for their kids (which, nutrition alone, has been shown to return $3 for every $1 spent when the kids reach adulthood) instead of inflating bubbles by allowing the wealthy to do things like buying up all the housing stock to beggar thy neighbours, or making sure the newest Rolex release is worth double MSRP in a year… but in Canada as in the US fellating billionaires while inflicting pain on everyone else seems to be the chief concern.
Japanese economy revoles around savings based model. People saved more despite interest rates going down in the negative. So, not a good example.
The claim is not that low interest rates only increase inflation when consumers aren’t saving (i.e., inflation is driven by consumption and NOT interest rates). It is that low interest rates directly contribute to inflation. So Japan is a very a good example because it shows that low interest rates do not increase inflation. There’s quite a lot of empirical work done by Richard Werner that shows there is little evidence to correlate interest rates and inflation.
Unless you want 1 USD = 155 CAD please save all silly comparisons to Japan.
The Yen is low because Japan is a defeated and conquered nation with no independent or sovereign policies. All of their central bank decisions have been made to please their master across the Pacific at the cost of its aging and zombified citizenry.
Shinzo Abe made the fatal mistake of stepping out of line.
I’ve been winning over the last year with my variable mortgage.
Nah, you’re winning against yourself.
You could have got a 5-year fixed for less than a variable for almost 2 years now. So yes, you’re paying less than before but even averaging down on the amount you would only save money if there’s a pandemic and the gov forces trade to shut down. Oh wait… LOL.
This is criminal and the banks should be charged. Lower interest rates are needed to support house prices. Canadians have worked hard to buy homes and should be supported with their investment.
Bond yields have been tanking for some time now. The banks have been increasing the spread to continue to charge customers more on fixed rates. We typically see a spread of 0.7-0.9, now we are seeing spreads at 1.2-1.5. At today’s rate of 2.69% on a 5 year bond, realistically a 5 year fixed should be around 3.4%, however they are still over 4%. It’s not the overnight rate cuts that’s are costing consumers, it’s still bank greed…
The problem needs to be viewed from all sides.
1. Tariff both sides 25% may sound tit for tat. But it impacts consumers.
Suggest that Canada waves HST until things settle down.
Importers and exporters of Canada get HST exemption as well as Govt. Subsides 10%
So total 25% does not impact importers and exporters and no impact on Canada consumers.
2. Jobs situation.
Millions of jobs are gone offshore leaving local unemployment.
Get hold of the registered big off shore branches who are doing this and tax and penalize them.
Also penalize the Canadian corporations that are supporting these offshore branches in Canada and laying off people in Canada.
Also offshore companies branches in Canada are getting workpermit employees from overseas with low income.
These are workpermits reported as branch transfers, hence these employees don’t contribute to CPP there by CPP funds are shrinking.
This must stop and local unemployed must be back to be hired.
If these two major things are taken care of then economy will be back to normal.
I couldn’t agree less. This looks like FUD designed to keep people away from variable rate products in a market that is headed for recession and low, low rates. In the past 25 years I have held variable rate mortgages for 20 of those years with only benefits to claim. Last renewal, beginning of COVID, I went fixed – solid move – and now we are back to variable friendly territory. Follow any advice from this bunch at your peril.
So the author very astutely points out thst due to chronic micromanagement of monetary policy, meant that it was central and commercial banks who are always 100% responsible for systemic ‘inflation’.
It would be better termed as deflation of the value of money by a failure to restrict expansion thrpugh bad policy and greed.
Sonce the 18th century the solutipn to this has been the business cycle -expansion and retraction of gdp because of bad bank regulation and too much discretion in lending to commercial banks.
This is the root cause of canadas gdp per capita crisis in canada. Similarly the dumb reactipn of the feds to trump, has exasperated the issues.
So for a risk adverse bond buyer, the risk is obviously higher than the boc would have us believe. Even 3 mos if the dumb retaliatory tariffs will cause seripus stress on consumers. This segment is already overloaded with taxes, d3bt and inflation.
Worse still out banks are at risk because this is their only.buainess and despite freeland taking on evwr increasing mortgage credit risk onto the taxpayor, the banks are obviously at peak valuation.
The trade war will lujely resolve in q2 or q3, so we may avoidthe.worsy of it, mainly because premietsmith, in a complete.vacuum.of leadership on canada, secured a break to 10% to 47% of our exports.
Even more bizarre is how various dim wits in central canada condemned her for doing it?
Sith leadership like thay who is worried about trump?