Canadians believe interest rates will fall soon, and it’s now obvious in real estate. That’s the take from BMO Capital Markets, who sees this having unintended consequences. In a weekend research piece, they explain more investors are holding out for rate cuts. This will lead to maintaining lofty growth expectations and sticky inflation, making cuts counterproductive. Consequently, the bank warns they don’t see any room for interest rate cuts next year.
Canadian Investors & Households Expect Interest Rates To Fall
The Bank of Canada (BoC) seemed to backtrack on its message last week. Up until last week, the central bank spoke of higher and uncomfortable rates. Last week’s rate hike came with a different message—they’ll debate future actions. It is widely seen as a sign the market won’t be able to take higher rates, and would be reversing course.
Combine that with a weaker economy and falling rates, and it’s easy to assume rates are too high. BMO points to the TSX, which is down roughly 5% from last year as corporate outlooks erode. The point that stands out is the yield curve.
The yield curve has inverted, meaning short-term interest rates are higher than long-term. Canada’s 10-year bond yield is now 140 basis points (bps) lower than the overnight rate. According to BMO’s research, the gap has almost never exceeded 50 bps, and is now at a 30 year extreme. It’s a strong indicator of recession, with the market demonstrating they see big rate cuts.
What does that mean? “Essentially, the market is assuming that the Bank will be slashing rates by the second half of next year as—presumably—inflation melts away,” says Douglas Porter, chief economist at BMO.
Canadian Real Estate Markets Demonstrate The Expectation of Lower Rates
Canadian real estate markets are the most obvious example of rate-cut expectations. The bank estimates this week’s national numbers will show sales fell 40%, with a 4% drop for prices. Despite these weak indicators, new listings are showing signs of stabilizing. Rental prices are even booming, despite staring down the barrel of a recession.
“If anything, the market’s fundamentals may show stabilization amid a pullback in listings. Both potential sellers and heavily indebted owners are likely holding on, waiting for rates to ultimately recede,” says Porter.
BMO Forecasts Interest Rates Won’t Be Cut In 2023
The widespread adjustment of behavior ahead of rate cuts means they can’t be cut. “This is where we distinctly deviate from the consensus and the markets,” says Porter.
The bank is forecasting inflation will be significantly higher than consensus next year. Consensus has annual growth pegged at 3.8%, which is nearly double the target rate. However, Porter sees growth at 4.6% over the same period—leaving no room for an interest rate cut next year. They see rates at least at the neutral level right through 2023.
“In a word, that pullback in yields just means that the Bank will need to keep short-term rates higher for longer as a counterweight. You can fight the BoC, or the Fed, but you can’t win,” he warns.