The Bank of Canada (BoC) has just bucked its seven-year trend, hiking its Overnight Lending Rate by a quarter of a per cent to 0.75. The Bank Rate is correspondingly 1 per cent, and the deposit rate is 0.5 per cent.
It’s a move that signals the economy is on a strong enough uptick for the central bank to ease up on the measures it put in place to aid recovery after the recession and weather the impact of low oil prices in 2015. (Keeping interest rates low in weak economic times helps protect credit liquidity and promotes continued consumer borrowing and spending.) This is done by pricing the Overnight Lending Rate, which is then used by Canadian lenders as a guide to setting their own Prime rates, dictating the cost of variable-rate loans and mortgages.
Responding to a Stronger Economy
The hike is supported by strong job numbers, as well as improving conditions in the U.S. economy, despite inflation – one of the BoC’s key measures – lagging below its target.
“Recent data have bolstered the Bank’s confidence in its outlook for above-potential growth and the absorption of excess capacity in the economy,” states the BoC’s release. “The Bank acknowledges recent softness in inflation but judges this to be temporary. Recognizing the lag between monetary policy actions and future inflation, Governing Council considers it appropriate to raise its overnight rate target at this time.
Related Read: May 2017 Bank of Canada Rate Announcement
“Canada’s economy has been robust, fuelled by household spending. As a result, a significant amount of economic slack has been absorbed.”
It adds that the adjustment to the lower oil prices that prompted rate cuts in January and July 2015 is “largely complete”, and that there is promising expansion in the goods and services sectors, supported by rising employment and wages and strengthening business investment.
However, while it projects slack in the Canadian economy will close by the end of this year – earlier than previously expected – real GDP growth will weaken over the next few years, moderating from 2.8 per cent in 2017 to 2 per cent in 2018 and 1.6 per cent in 2019. It also expects inflation to hit its long-coveted benchmark of 2 per cent in 2018, as the factors behind its lag – competitive food prices, energy rebates, and lower auto pricing – fade.
On a global scale, the BoC nods to the solid pace of growth in the U.S., and improvement in the euro area, but notes “geopolitical uncertainly still clouds the global outlook, particularly for trade and investment”, and that global oil prices remain soft due to supply and demand imbalances.
So Rates Are Up… Now What?
Today’s interest rate increase was widely expected – analyst sentiment unanimously called for one as this month’s encouraging economic data was reported. BoC Governor Stephen Poloz also greatly contributed to speculation with comments made earlier this month that the Bank would not wait solely on inflation before making a move. “If we only watched inflation and reacted to inflation, we would never reach our inflation target, we’d always be two years behind in the reaction,” he told German news outlet Handelsblatt. “When you are driving toward a red stoplight, you ease up on the accelerator well before you get there instead of waiting for the last second to stop.”
The immediate aftermath is that interest rates for variable-rate borrowing products (like mortgages and LoCs) will rise, though it remains to be seen whether banks will pass the entire 0.25 per cent increase onto their own pricing.
UPDATE: All big five banks (CIBC, Scotiabank, BMO, TD and RBC) have since priced in the increase, raising their Prime rates to 2.95 per cent.
Fixed rates, while not directly impacted by the BoC’s rate, have also fluctuated in response; bond yields have been rising ever since Poloz’s comments, says James Laird, president of CanWise Financial.
“Bond yields are up 50 to 60 basis points, and mortgage rates are still adjusting, but they more or less followed suit,” he says, adding that they could move again depending on whether the BoC alludes to whether more hikes will come. In that regard, the BoC has certainly left the door open to the possibility, though keeping a cautious tone.
“Governing Council judges that the current outlook warrants today’s withdrawal of some of the monetary policy stimulus in the economy,” it states. “Future adjustments to the target for the overnight rate will be guided by incoming data as they inform the Bank’s inflation outlook, keeping in mind continued uncertainty and financial system vulnerabilities.”
Will This Hurt the Housing Market?
Record low borrowing rates have long been pointed to as fuel for Canada’s heating housing market – and highly-indebted households. However, now that the nation’s hottest markets are experiencing slowing sales – activity dropped 37.3 per cent in the Greater Toronto Area in June – will the higher cost of borrowing put more negative pressure on buyers and sellers?
Lauren Haw, Broker of Record and CEO of Zoocasa Realty, points out that it’s still an extremely cheap environment for borrowers, as rates have consistently dropped over the past few years, and that historically, rate fluctuations have not drastically impacted the Toronto real estate market.
“The increased benchmark interest rate of 0.25 per cent should not have an adverse effect on the housing market, as we are still in a very inexpensive lending period,” she says. “Mortgage rates remain at historical lows since the decrease seen after the 2008-2009 recession and it will take a series of increased rate hikes before we see a significant impact on homebuyers in Canada.”
“Reviewing TREB data following the last time rates were hiked in 2010, figures show that the pattern of home sales and prices didn’t change.”
I Have a Variable-Rate Mortgage – What Should I Do Now?
When rates are on the rise, the popular sentiment can lean toward locking into a fixed mortgage rate – which are guaranteed for the entire mortgage term until renewal – as they provide more peace of mind and financial security. However, Laird says today’s hike doesn’t automatically mean borrowers should flock to fixed-rate products, and that it’s important to assess your current tolerance for risk over the medium term.
“It is a very logical time to consider whether you should lock in, and weigh the various scenarios,” he says. “Scenario A is a borrower saying, ‘I understand there is upward pressure on rates, and there will be exposure to more interest rate pressure over the next five years, and my strategy is to stick with variable because historically it has been cheaper.’
Scenario B is if, during this self-analysis, they say, ‘My appetite for risk has gone down since I got the variable rate, and I now see the value of locking in my rate payments, even though they’ll automatically be higher than what I currently have, and will hedge risk and will let me budget perfectly.’”
The Bank of Canada’s next rate announcement is scheduled for September 6, 2017.