Today the Bank of Canada increased its Overnight Lending Rate by 25 basis points, the first increase we’ve seen since the start of the COVID-19 pandemic.
The Central Bank had previously slashed the trend-setting rate by 150 basis points when the pandemic broke out to support the economy, bringing rates down to an all-time low. However, with economic recovery well underway and inflation at its highest since 1991, the Bank kicked off the tightening cycle it signaled was coming in its January announcement.
This rate increase was highly anticipated by financial experts and is expected to be one of the many hikes we see this year. This was confirmed by the Bank today, which said “as the economy continues to expand and inflation pressures remain elevated, the Governing Council expects interest rates will need to rise further.”
The Bank has again signaled its commitment to return back to its 2% inflation target, a significant decrease from the current level of 5.1%; however, they noted in their most recent announcement that inflation is likely to stay elevated in the near term.
While the Bank had previously attributed many of the inflationary pressures the country is currently experiencing to short-term supply chain issues caused by the pandemic, the Russian invasion of Ukraine, and subsequent geopolitical and economic consequences of the event, could cause long-term inflation and impact to commodity prices and availability. The Bank will be closely watching the event to determine the best course of action for Canadian Monetary Policy.
Despite heightened global pressures, the Canadian economy is outperforming the bank’s expectations. Q4 of 2021 was the strongest quarter of that year, at 6.7%, outmatching the bank’s projections in the January Monetary Policy Report. Overall, growth for the first quarter of 2022 is looking stronger than expected as well.
What Do Rising Rates Mean for the Housing Market?
Canadians watching the housing market are waiting to see what, if any, impacts this year’s rate increases will have on the real estate market. If you’re in the market, here’s what you need to know:
1. Previous Tightening Cycles Reduced Market Urgency, But Not Necessarily Product Price Points
Zoocasa recently analyzed what happened in the Toronto Region real estate market the last time that interest rates rose in 2017-2018. The key findings from this report included that:
- Although home prices faced a strong decline in 2017, this can be strongly attributed to new government policies introduced to help cool the market during that time – like the Ontario Fair Housing Plan, which included a Foreign Buyer Tax. This major decline took place before the Bank began its rate hike cycle, and in the year after the rate hikes began prices had remained stable.
- Rising interest rates did show a correlation with lower sales numbers, 2018 had the lowest number of sales in the Toronto Region in recent memory; however, it’s more likely that the introduction of the Stress Test that year, which reduced buyer’s budgets by an estimated 20%, had a more significant impact on cooling demand.
In short, raising interest rates signal economic change, and this uncertainty definitely contributes to prospective buyers and sellers being a little more cautious about getting into the market – but this caution didn’t materialize into a reduction of average sales prices in the last rate hike cycle. CEO of Zoocasa, Lauren Haw explains:
“If we take a closer look at what happened in the last interest rate increase cycle in 2017-2018 in the Toronto Region, we can see that policy, not rising interest rates, had the largest impact on cooling the red-hot housing market we had seen in early 2017. While sales activity did cool during that increase period, prices remained relatively flat. Rising interest rates seemed to remove some of the urgency from buyers and sellers who wanted to wait and see what was next for the economy, but didn’t reduce the average price on the market – and I’d anticipate we can expect a similar phenomenon to occur in light of this year’s rate increases.”
Related Read: Here’s What Happened Last Time Interest Rates Rose
2. The Stress Test Added Protection for Canadians
The Stress Test was designed to protect Canadians from becoming financially at-risk when interest rates inevitably increased from their historically low levels. As a result of this legislation, buyers since 2018 have had to qualify for a mortgage rate that’s higher than their contract rate when getting a mortgage.
According to a February article by Reuters, more than 90% of mortgage borrowers in Canada are stress-tested at a rate of 5.25%. Meaning, they needed to qualify for their mortgage at a 5.25% rate, in preparation for higher rates in the future.
Despite the fact that housing costs in Canada are higher than ever, according to OFSI, residential mortgage credit risk has only risen modestly due to the margin of safety created by the Stress Test.
Outside of protecting existing borrowers, the stress test also means that today’s change in rate won’t have an immediate impact on buyers’ maximum mortgage qualifications. Due to the test, today’s buyers need to qualify at either 5.25% or their contract rate plus 2%, whichever is higher. Even after today’s hikes, the best home loan rates available plus 2% still fall below 5.25%. It will take multiple rate hikes for buyers’ maximum budgets to change.
3. Most Mortgage Borrowers Won’t See an Immediate Change In Their Payment
About three-quarters of total outstanding mortgages in Canada are fixed, and for these borrowers, today’s news of rising interest rates won’t have any immediate impact on their monthly payment, since their mortgage rate is set for the entire duration of their term. However, when it’s time to renew their mortgage, this group will likely see higher rates than their previous term.
For variable rate borrowers, today’s announcement will impact your mortgage – either by increasing your overall payment or reducing the total amount of your payment going toward your principal.
Should Rising Interest Rates Change My Spring-Market Strategy?
If you’re planning to buy or sell a home this spring, talking to a licensed real estate agent is a great first step in developing your strategy in light of today’s announcement.