Canadian borrowers have been feeling the squeeze of rising interest rates since March, when the Bank of Canada first hiked its Overnight Lending Rate in response to rising inflation -- but they’ll need to brace for much higher rates in a hurry, according to one of Canada’s largest consumer lenders.

An economist from the Bank of Montreal is calling for the central bank to implement another three half-point increases over its next few rate policy announcements, bringing the cost of borrowing to 3% by October. This speeds previous expectations for the BoC completing its hiking cycle by six months, and at a higher level than neutral.

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“Previously, we judged the Bank would stick to 50 [basis point] moves at successive meetings until the policy rate hit the 2% bottom of the neutral range. Then, it too would shift to a more tentative stance, hiking rates by 25 bps every second meeting until hitting 2.75%, just below the top of the range. But, like the Fed, we see that policy caution being abandoned, with no pauses and rates peaking 25 bps higher and six months earlier than before,” writes Michael Gregory, BMO’s Deputy Chief Economist, in a note.

Once the rate settles at 3% and GDP growth slows, he then expects both the BoC and the U.S. Fed to level out on monetary policy, holding steady as inflation slowly lowers back to its 2% inflation range by 2023; Canadian CPI clocked in at 6.8% in April, the highest in 31 years.

“We judge the risks of rates moving into restrictive territory during the interim due to the lack of inflation improvement are greater than the risks of early easing owing to better-than-expected inflation performance,” Gregory adds.

Expectations for the BoC to move more aggressively largely evolved after minutes from the last Federal Reserve announcement revealed American monetary policy makers plan to move aggressively with another two half-point hikes of their own as inflation rate soars higher; it hit a new 40-year record of 8.6% in May.

As the BoC and Fed tend to move in lockstep on rates, that prompted economists to believe the 0.5% increases the BoC made in April and June wouldn’t be isolated incidents. The BoC has increased its OLR three times since March, via one quarter-point hike and two halves, to bring the rate from 0.25% to 2.5%.

Gregory says that BMO’s call shifted following the Bank’s most recent policy announcement on June 1 -- which surprised analysts with its increasingly hawkish language that stated “the Governing Council is prepared to act more forcefully if needed,” -- as well as a speech given the following day from Deputy Governor Beaudry, who stated, “the likelihood that we may need to raise the policy rate to the top end or above the neutral range to bring demand and supply into balance and keep inflation expectations well anchored.” 

“This was a powerful signal,” writes Gregory.

Rapidly rising interest rates are already being felt in household’s debt servicing budgets, but will be especially hard-hitting for borrowers who took out market-facing mortgages over the last two years, when home prices inflated to new highs during the pandemic. According to the Financial Systems Review released by the BoC yesterday, these highly-indebted households pose a key risk to the Canadian economy, especially should a “trigger” event occur.

According to the BoC’s calculations, a household that took out a mortgage between 2020-2021 will see a median increase of $420 -- or 30% -- in their monthly mortgage payments upon renewal. For variable-rate borrowers, that increases to $700 per month, while fixed-rate borrowers will see payments increase by $300. The difference, says the Bank, is due to variable-rate borrowers taking out generally larger mortgages during the pandemic, given their historical lows.