Canadian real estate buyers may be disappointed by the lack of relief they got from a supersized rate cut. A new BMO investor memo explains the Bank of Canada (BoC) overnight rate cut only provides relief to variable rate mortgages and HELOCs. Since more popular fixed rate mortgages are cheaper, buyers hoping for a cheaper option saw no relief. They don’t see much relief in the future either, since these loans have already priced in future rate cuts.
Bank of Canada’s Overnight Rate Impacts Variable Loans, Government Bond Yields Impact Fixed Rate Loans
Credit is competitive, meaning loans with similar terms tend to move with each other. The BoC slashing the overnight rate helps to provide relief to those with variable cost loans dependent on short-term borrowing costs. These types of loans include HELOCs and variable rate mortgages. The latter became popular during the recent binge of low-rate exuberance, but remained a small share of the mortgage market.
Fixed-term mortgage rates are influenced by Government of Canada (GoC) bonds of similar length. Since they have slightly more risk than a GoC bond, they carry a slight premium. This means a 1-year fixed rate mortgage will be offered at a cost similar to the 1-year GoC bond plus the premium. A 5-year fixed term mortgage is the most popular borrowing tool, influenced by the 5-year GoC bond yield, typically the most popular government bond offered.
GoC bond yields are directly tied to an inflation outlook. Strong economies tend to have strong consumption, which boosts inflation. The 5-year bond yield (and a 5-year fixed rate mortgage) would be boosted by a strong outlook and inflation. It works the opposite way too, with a weak economic outlook helping to push the cost of borrowing lower.
Now that we’re on the same page, let’s discuss what yesterday’s rate cut did, and didn’t do.
BoC Cuts Helped Variable Rate Mortgages & HELOCs, Fixed Rates Already Much Lower
Yesterday’s decision impacts short-term interest costs, but not medium or long-term costs. “Yes, those with outstanding variable-rate mortgages, or HELOCs, have caught some significant relief this fall thanks to the BoC,” explains Robert Kavcic, senior economist at BMO.
Adding, “But those rate cuts had already been priced into 3- and 5-year fixed mortgage rates. Indeed, Canadian 5-year GoC yields, which drive fixed mortgage rates, actually edged up on Wednesday.”
The cuts helped to lower HELOC and variable rate mortgages, providing a little income relief to boost consumption. However, it didn’t provide any further incentive to buyers. The more popular 5-year fixed term mortgage rate was already cheaper, and actually became slightly more expensive as a result of higher inflation expectations driven by higher consumption.
BMO notes the fixed-term mortgage has also priced in the next rate cut as well. “The BoC could very well cut rates a few more times, but another 50 bps of easing by June is already priced in,” Kavcic explains.
Further noting, “… given that we don’t see too much more downside for 5-year yields, the low for mortgage rates in a well-behaved economy might already be upon us. That is, somewhere in the low-4% range.”
Higher than pre-pandemic, but that may be good news for those looking to get into the market. The rate is low enough that it isn’t considered a major drag on borrowing, but high enough to lower investor incentive, BMO believes.
“At those levels, investment and affordability arithmetic is still challenging, which could keep a recovery in housing from getting out of hand…”
Hear this one all the time—waiting for rates to hit a bottom. Markets are generally efficient so the bond market reflects any anticipated rate cuts over the term.
Unlikely to get cheaper doesn’t mean there’s zero chance, but it’s the best estimate known with the current data.
This is the neutral policy rate, so the next cut would be considered stimulus. I guess that means borrowing is in stimulus territory, but not sure how to read that since sales are still weak historically.
Nooo. LOL. I guess that makes sense but I was holding out. How is it even possible for Canada’s economy to do this bad but rates needs to be much higher and not return to pre-2020 levels?
Short story is you know how they said credit is competitive? So are the borrowers. The Government is borrowing so you don’t have to.
They really shouldn’t be borrowing *on behalf* of other parties to exploit the credit supply but it’s hard to explain how this impacts people.
Articles recently on BD are just downers. What gives? Click bait?
That’s actually just you being a baby. The articles are objective information for people that need actual information. Ckcks like you that think your house is the only asset that can rise are the only people that think it’s “click bait” to repeat what an economist says.
Just over here, waiting for inflation to spike.
Kick out 5m people by the end of 2025 and rents will drop, hopefully leading to at least stagnant house prices. Owning a home ain’t easy but it’s not supposed to be a birth lottery, where the loser is the young families trying to grow by owning not renting a 2 bedroom main floor for 3k or heaven forbid a 2k 1 bedroom basement
For those individuals that do not follow the financial markets as closely than others, the Bank of Canada has cut interest rates five consecutive months in an effort to stimulate the economy and prevent it from stalling. This is in conjunction with the less restrictive US Federal Reserve policy as well. However, the US markets are currently factoring in a 83% chance of a 25 bps cut next week with the markets alsofactoring in a pause in January. This forecast is based on the month over month U.S CPI inflation indicator rising faster in the previos 3 consective months than the year over year CPI data. What does this mean for interest rates? Well for one thing, if the US Federal Reserve is forced to pause in the new year to see if inflation is actually rearing it’s ugly head again, the BOC will continue to stay on course with easing interest rates as long as the Canadian data shows that inflation is not making a comeback in Canada as well. With that said, the Canadian Federal Liberals announced last week that individuals who worked in 2023 will be receiving a $250.00 cheque in February. This stimulus cheque will be inflationary. The temporary suspension of GST that was also announced by the Liberals will also be inflationary. As such the BOC will need to take all of the above into consideration before announcing interest rate policy at the January Meeting.