Canada’s central bank made its first interest rate hike since slashing it down to nearly nothing. The Bank of Canada (BoC) announced it will raise the overnight rate today, marking a path to rate normalization. Today’s hike was widely expected, and the first of many that are forecast over the next two years. Rising rates will reverse the stimulus that armed investors and home buyers with mountains of cheap cash. Low rates are one of the key factors that allowed home prices to rise so quickly — during what was supposed to be a recession.
The Bank of Canada Doubles The Overnight Rate
The BoC raised interest rates today as expected, including the overnight rate. The overnight rate hit 0.5% this morning, double the rate seen during public health measures. It’s still a very low rate of interest, don’t get this wrong. It was considered rock bottom as recent as 2017, and is still expansionary for the money supply. However, a little stimulus disappears and some moderation of inflation is expected.
Variable Rate Mortgage Borrowers Will See An Immediate Impact
Most recent borrowers will feel the impact of a higher overnight rate immediately. Those with variable-rate mortgages, or buyers taking out one, will see the impact today. Every 25 basis point (bp) increase to the overnight rate adds ~15 bps to variable mortgage interest. Recently variable-rate mortgages became the majority of borrowing.
Need a more concrete walk-through? An increase of 15 bps on a mortgage works out to around $7 per $100,000 in mortgage debt. For a typical home in January with 10% down, buyers will pay ~$55/month more. Not exactly earth-shattering from a cost perspective and unlikely to cause defaults.
Especially since many variable rate mortgages won’t see a change in payment size. Instead these products often reduce the amount applied to principal. As home prices rise tens of thousands per month, it’s unlikely to phase anyone. Even borrowers getting a hike are likely still saving money from the fixed rates they were offered at the time of borrowing. It can change as rates rise further, but so far that isn’t the case.
Fixed-rate mortgages don’t see a direct impact from a rising overnight rate. Existing borrowers are obviously locked into their current interest costs. That aside, the interest rates on these products move with similar term bond yields. New borrowers would see a minimal (if any) change in rates after the hike. On a more long-term basis, rising overnight rates lead to rising yield expectations. This will see fixed costs rise later.
The Bank of Canada Is Expected To Raise Rates Quickly From Here
One rate hike isn’t likely to have a big impact on the market, but experts see many rate hikes coming. Our panel has forecast that the overnight rate will rise to at least 1.50% over the next year. It might seem like a lot, but that’s just the path to normalization. Many don’t seem to realize dropping from 1.75% to 0.25% was the equivalent of 6 rate cuts in 2020. Forecasts aren’t perfect, but this is the pace needed to stop monetary policy stimulus. This is also how they curb elevated inflation.
Higher rates can lead to slower home sales and/or price growth as buying power adjusts. Fixed-rate mortgages have been rising for the past year, but failed to slow down much. This is largely due to variable rates not following, like they typically should. The market expected the first hike up to a year ago, since it takes 18 to 24 months to be fully realized.
Consequently, higher fixed rate mortgages did little. It actually had the opposite impact. More people were incentivized to borrow variable-rates, and scoop the last of the cheap debt. Now variable rate mortgages represent the majority of recent loan originations, but that path is quickly closing.
While many argue higher interest rates will erode affordability, research from the BoC shows low rates are actually responsible for the decline in affordability. Cutting edge research from the central bank that only last year realized additional credit drives home prices higher.