And that’s a wrap on interest rate hikes in 2022 -- the Bank of Canada increased once more in its final rate announcement of the year, bringing its trend-setting Overnight Lending Rate up by 50 basis points to 4.25%, which will result in a Prime rate of 6.45%.
It is the central bank’s seventh consecutive increase since March, when it kicked off its rate hiking cycle in order to combat soaring inflation. As a result, the benchmark cost of borrowing has risen by 4% in the span of 10 months -- the steepest incline since the mid 90s -- which has materially increased debt servicing costs for variable-rate mortgage holders, as well as other market-facing loan products such as HELOCs and lines of credit.
That the BoC opted for a harder approach with its final hike reflects that inflation concerns remain persistent both north and south of the border. Analysts were largely split leading up to today’s rate decision on whether the central bank would make a quarter- or half-point hike, given conflicting economic data; stronger-than expected GDP and jobs growth indicate the economy is still burning hotter than policymakers would like, further fueling inflation.
“Inflation around the world remains high and broadly based. Global economic growth is slowing, although it is proving more resilient than was expected at the time of the October Monetary Policy Report (MPR),” states the BoC. “In the United States, the economy is weakening but consumption continues to be solid and the labour market remains overheated. The gradual easing of global supply bottlenecks continues, although further progress could be disrupted by geopolitical events.”
The statement adds that the Canadian economy continues to operate in excess demand, while unemployment remains near historic lows. However, “there is growing evidence that tighter monetary policy is restraining domestic demand: consumption moderated in the third quarter, and housing market activity continues to decline,” writes the Bank. “Overall, the data since the October MPR support the Bank’s outlook that growth will essentially stall through the end of this year and the first half of next year.”
While there have been some positive inflation trends in recent months -- the measure eased to 6.9% in October -- the BoC points to the large price increases that continue to face Canadians, especially food prices.
“Three-month rates of change in core inflation have come down, an early indicator that price pressures may be losing momentum,” reads their statement. “However, inflation is still too high and short-term inflation expectations remain elevated. The longer that consumers and businesses expect inflation to be above the target, the greater the risk that elevated inflation becomes entrenched.”
One key -- though subtle -- difference in today’s announcement lies in the Bank’s forward looking language, stating Governing Council will be “considering” whether the policy interest rate needs to rise further in the new year, rather than explicitly stating so.
“Governing Council continues to assess how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding. Quantitative tightening is complementing increases in the policy rate. We are resolute in our commitment to achieving the 2% inflation target and restoring price stability for Canadians,” it writes.
It’s widely believed by the market that the Bank likely has one more rate hike in store in the new year, before reaching a terminal rate in the range of 4.25%, and stabilizing in the months to come.
That could spell some rate relief for beleaguered borrowers; but at the same time, concerns are growing of an impending recession. The latest GDP data revealed domestic demand contracted by 0.6% in Q3, the first economic contraction recorded since the second quarter of 2021. That was largely pulled down by the chilling real estate market, as residential investment plunged by 15.4%.
Canada’s bond market is also displaying the widest yield curve inversion (when two-year bond yields have become more expensive than those of 10-year) since the early 90s. This phenomenon, which reflects investor pessimism in the short-term economic picture, is considered a fairly accurate predictor of recession, having preceded each downturn since 1980.
The Impact on Mortgage Borrowers
Today’s rate increase holds the greatest implications for variable-rate mortgage holders, as their interest rates are directly influenced by the BoC’s Overnight Lending Rate; consumer lenders use this rate as the benchmark for their Prime borrowing rate, which in turn sets the pricing for their variable mortgage and credit products.
“The impact will be felt first by Canadians with variable-rate mortgages that do not have fixed payments and those who carry a balance on a home equity line of credit (HELOC). This group will have their payments adjust immediately to reflect the full impact of the rate hike,” said James Laird, Co-CEO of Ratehub.ca and President of CanWise mortgage lender.
Those who have variable mortgages without fixed monthly payments will see the amount they need to pay increase immediately. Those who pay the same amount each month will instead see more of their payment go towards interest rather than their principal debt.
Of course, today’s hike increases the risk that more of these borrowers will hit their trigger rate, meaning their payment no longer contributes to principal and covers their interest portion only -- something that is banned under the Canadian Banking Act. In more severe instances, borrowers may hit their trigger point, meaning their overall mortgage balance has ballooned due to rising interest costs, wiping out any built-up equity and exceeding their original loan value. In both of these instances, borrowers will be contacted by their lender to discuss their options which can include making a larger lump sum payment or extending their overall mortgage amortization.
According to Laird’s analysis, today’s increase means variable-rate borrowers will pay $1,415 more per month on their mortgage, based on an interest rate of 4.9% and the Canadian average home price of $748,450 in January 2022; their overall monthly payment will now clock in at $4,000.
“This means that by December of 2022, the total impact year-to-date for the homeowner is $1,415 more per month or $16,980 per year on their mortgage payments (a 55% increase),” he writes.