Canada’s variable rate mortgage borrowers—brace yourself. BMO Capital Markets has made another upward revision to its interest rate forecast this week. The bank was forced to make a revision as sticky inflation and rising wages require much higher interest rates to cool activity. Canada’s overnight policy rate is now forecast to hit the highest level in over a decade, and that’s not great for home prices.
Bank of Canada Policy Rate Forecast Rises Once Again
The Bank of Canada (BoC) surprised many with its rate hike earlier this month. Despite the market pricing in 75 basis points (bps), the central bank went with a 50 bps move. At 3.75%, the policy rate is now the highest in over a decade, and many assumed a smaller hike indicated we were close to peak. Not exactly.
BMO just hiked its forecast for the terminal rate—the point where rates peak. They see the BOC hiking an extra 50 bps, with a terminal rate of 4.5% now. This would be 25-50 bps below their target for the US Federal Reserve, potentially leading to a weaker loonie.
Sticky Inflation and Soaring Wages Are Driving Costs Higher
Interest rates have been soaring in an attempt to slow inflation, and that’s driving the current upward revision. “reason for the rise (again) is stubbornly high core inflation and wage growth, with the latter occurring amid still-sturdy labor market conditions. This means the central banks have even more work to do to restore price stability,” said BMO economist Michael Gregory.
Economists warned of the potential for an inflationary spiral if left too high for too long, and that might be here. An inflationary spiral occurs when high inflation erodes at wages so fast, worker need much higher raises to cope. Since wages are input costs, the larger the increase the higher prices need to rise to accommodate the increase. The higher prices need to rise… you get the picture.
“ On both sides of the border, overlapping inflation and wage growth point to a sprouting wage-price spiral, one that’s going to require more aggressive central bank tightening to eradicate,” said Gregory.
If the terminal rate forecast is reached, Canadians will face a policy rate this generation has rarely seen. In the past 20 years, only six months in 2007 have matched the forecast level. That means home prices are going to need a major adjustment, as former BoC Governor Poloz recently mentioned.