Buckle up, mortgage borrowers -- another half-point interest rate hike is coming on Wednesday from the Bank of Canada (BoC), sealed by April inflation hitting a new 31-year high, and a similar aggressive monetary policy approach unfolding south of the border.
It will be the second 0.5% increase implemented by the BoC in as many months, bringing the central bank’s trend-setting Overnight Lending Rate to 1.5% and officially marking the fastest-paced hiking cycle seen in decades; the half-point increase made on April 13 was the first since the year 2000.
It will also bring interest rates nearly back to their pre-pandemic levels: the OLR was 1.75% at the start of March 2020, before it was slashed to 0.25% in a number of emergency announcements in response to COVID lockdowns and the shuttering economy. Typically, the BoC makes its policy moves in quarter-point increments.
The Cheap Money Reversal
Borrowers have been reveling in that historically cheap money ever since, which in turn has helped drive up housing prices over the last 24 months. Now, the concern is that rapidly rising mortgage and HELOC costs could result in a dramatic hit to household budgets, as Canadians are also squeezed by spiking inflation, which clocked in at 6.8% in the April reading.
That’s triple the lower end of the BoC’s target for CPI, and it must hit its “neutral” range of 2 - 3% in a hurry in order to combat it. As such, more hikes are promised in the coming months. According to analysis from RBC, the OLR is set to hit 2.5% by October leading consumer lenders to increase their Prime rate to 4.7% (1.5% higher than today’s 3.2%).
“The looming question is whether rates need to rise above that neutral range to get inflation back under control. So far, surging inflation has been as much a result of extremely strong demand as supply limits. Higher rates should work to address some of that pressure,” reads the note, which was authored by RBC Economist Claire Fan and Assistant Chief Economist Nathan Janzen.
“Indeed, the initial impact of rising interest rates is already being felt in the housing market, where resales have cooled significantly and prices declined for the first time since the beginning of the pandemic. But with other central banks (including the U.S. Fed) also hiking rates more aggressively, global spending and inflationary pressures are likely to gradually ease. We look for the Bank of Canada to raise the overnight rate to 2.5% by October.”
As they point out, the impact of rising rates is already being felt in the real estate market; following the BoC’s first quarter-point hike in March, Canadian home sales had tumbled 12.6% by April, with the pace of price growth slowing substantially. Price drops are also being observed in markets known for their froth, such as the GTA suburbs and exurbs; the average price of a home in the Durham, Halton, York, and Peel Region markets have all dipped between $74,000 - $160,000 from March.
And there's more room for prices to drop further; BMO’s Senior Economist Robert Kavcic wrote last week that today's cost of housing was a whopping 38% above the historical trend -- the greatest deviation in 40 years -- in the first quarter of this year.
“Now,” Kavcic wrote, “the Bank of Canada is on the scene and the market is softening sharply in some areas. So, when we speak of a housing correction it’s not a question of if, but where, how much and for how long?”
READ: Is Now the Time to Buy?
While improved housing affordability is likely welcome news for today’s prospective homebuyer, it would appear most borrowers would appreciate if the BoC would slow its roll; a recent study from the Angus Reid Institute found 45% of respondents would prefer the central bank take a “wait and see” approach on the OLR, to observe how tighter borrowing costs will impact the economy before taking further action.
The survey also found one-third (32%) of Canadians expressed difficulty in paying for their housing costs, whether renting or paying a mortgage. This includes 9% of those who are categorized as “struggling”.
