Canadian real estate markets have been warming up with dreams of cheaper mortgages. Despite the Bank of Canada (BoC) making no changes yesterday, they may have changed expectations. In a note to investors, BMO explained the central bank’s messaging demonstrates cuts are a long way off, potentially backstopping progress made on fixed rates. The bank is telling borrowers they’ll have to wait for relief, and won’t see any ahead of the busy Spring market.
Canadian Mortgage Rates Are Impacted By Different Channels
Canadian mortgages have two broad groups of interest costs, variable and fixed rate interest. Variable rate mortgages change with the central bank’s key interest rate—the overnight rate. Fixed rate mortgages have interest costs fixed for the term, and are influenced by Government of Canada (GoC) bond yields of similar length.
The BoC announcement (or lack of) technically only impacts the overnight rate. However, as BMO notes to investors—the outlook will have a significant impact on interest expectations for both segments.
No Change To The Overnight Rate, But Big Changes For Expectations
Let’s start with the overnight rate, which saw no changes at yesterday’s announcement. That was widely expected, but the BoC’s shift from threatening higher rates if needed to discussing cuts was not. In addition, the central bank doesn’t see inflation returning to target until 2025, much later than most anticipate.
“The Bank of Canada dealt no surprises leaving rates unchanged on Wednesday and, while language changes show even more clearly that they are done raising rates, rate cuts are still some time off,” explained Robert Kavcic, a senior economist at BMO.
In a research note to investors, he explained why the higher-for-longer messaging will impact fixed rates as well.
Canadian Bond Yields May Stop Providing Fixed Rate Relief
On the fixed rate side, mortgage rates have been falling with yields, which peaked back in October. The result is the 5-year fixed rate mortgage has shaved off roughly 1 point over that period, which can translate into big savings for borrowers. While the overnight rate technically doesn’t impact these, bond yields rise and fall with expectations. As the bank notes, the expectation of inflation taking longer to normalize is having a big influence on bond yields.
Those falling yields have recently bounced, rolling back nearly a fifth of the decline over just one week. “Indeed, after the market got a bit too ahead of itself pricing in near-term rate cuts to start 2024, we continue to look for a June move,” said Kavcic.
Rising yields have yet to translate into mortgage rates rising, but they still can. At the very least, BMO sees this as a backstop to further relief in the near-term.
Canadians Will Have To Wait For Mortgage Relief, Warns Bank
Canadian mortgage interest costs are almost certain to come down, but when? According to the bank’s outlook, don’t expect much (if any) relief before the busy Spring market.
Source: BMO Capital Markets.
“For mortgage rates, this means that more relief is going to have to wait,” stated the bank.
They see the Spring market getting a boost from the narrative of cheaper mortgages. However, when it comes to fixed rates they think it may be a while before further relief appears.
“Lower five-year fixed rates and expectations that the ‘worst for rates is over’ will likely set up a firm spring market, but a recent modest back-up in yields could stall that downward rate momentum,” he explained.
Kavcic expects variable rate relief is coming, but it’s too early to even discuss. He gives a mild warning to investors, “variable rate cuts, of course, would be a story for the second half of the year. Overall, rate relief is still on the horizon, it’s just going to take some more slogging to get there….”
So a long way off meaning a few months 😅🤡