Will the US Fed Rate Hike Mean Higher Canadian Mortgage Rates?

It isn’t just rapidly heating real estate prices barring some buyers from the housing market – a trend of rising rates is underway south of the border with implications for Canadian mortgages.

The U.S. Federal Reserve (the American counterpart to the Bank of Canada) announced yesterday a hike to its trend-setting interest rate by a quarter of a per cent, from 0.75% to a full 1%.

The move was justified by a strengthening American job market and improving inflation according to the statement released by the Fed: “The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labour market conditions and a sustained return to 2% inflation.” This is the second time the U.S. Fed rate has been hiked since December, with another two upward moves widely expected 2017.

Signalling a Stronger U.S. Economy

The Fed’s move is a signal it no longer needs to rely on ultra-low interest rates for economic recovery. But what will this rate increase mean for Canadians, who have also enjoyed record low borrowing rates since the financial crisis?

The likeliest outcome is that the fixed cost of borrowing will rise says CanWise Financial President James Laird, who points to the resulting sell-off occurring in the bond market.

“The quarter-point increase in the U.S. Federal interest rate typically results in the same increase for fixed rate mortgages here in Canada, which we should expect to see in the coming weeks,” he says, adding that new mortgage premium increases also taking effect this week will be a double hit to borrower affordability. “(This is) adding to a prospective buyer’s total monthly carrying costs and making the mortgage amount a buyer can qualify for incrementally less.”

Will The Bank of Canada Follow Suit?

While fixed rates are poised to rise, it’s still unclear if the Bank of Canada will follow the Fed’s lead with a hike of their own. Our central bank has kept its trend-setting overnight lending rate at just 0.5% since July 2015, following two quarter-rate cuts in reaction to dropping oil prices. Prior to that, it had been held at 1% since September 2008 in efforts to keep credit and money flowing post-recession. In recent announcements, the BoC has taken a very dovish tone, saying that due to “excess capacity”, cutting rates would be a much more likely tactic than raising them.

And, while historically Canada’s bank has mirrored the U.S. in terms of monetary policy, several recent statements made from its governor and deputies indicate that isn’t necessarily the case now. In January, Governor Stephen Poloz stated that the BoC will “continue to run an independent monetary policy, anchored by our inflation target of two per cent,” even if it resulted in a lower Loonie.

The Pressure to Keep Pace

However as this divergence widens, pressure is mounting on the BoC, says Laird. “An increase like this in the U.S. does place more pressure on the Bank of Canada to make a move, but for now we still expect to see our key overnight rate remain at 0.5%.” He adds that as fixed mortgage rates become less of a bargain, demand will grow for variable-rate options, especially if the BoC intends to keep their rate low. “If that remains true, a fixed rate increase will widen the spread between fixed and variable rates in Canada so you can expect variable rates to rise in popularity in 2017,” he says.

The bond market, which sets the trend for fixed-rate borrowing costs, seems to be leaning toward upward movement from the BoC, with two-year bond yields hitting two-year highs and overnight swaps pricing in a 51% chance of a hike by December.

Rising Rates, Rising Prices: CREA

News of potentially higher mortgage rates is accompanied by fresh data from the Canadian Real Estate Association, whose February numbers show the average home sale price is up 3.5% nationwide. While some markets are showing stronger growth than others, CREA reports upward movement in 70% of housing centres, with the Greater Toronto Area driving the bulk of growth.

“Housing market trends continue to differ by region. Homes are selling briskly throughout the Greater Toronto Area and nearby communities,” stated Cliff Iverson, CREA president. “Elsewhere, competition among potential buyers is less intense, so listings take longer to sell.”

CREA adds to other associations’ concerns of tight housing supply as listings declined in over a third of markets including in the Prairies, Ontario and Atlantic regions – in fact, the number of homes available for sale fell 25% and is at its lowest level since 2001.

Gregory Klump, CREA’s chief economist, says lack of options are driving the bidding war culture prevalent in the Toronto real estate market. “In and around Toronto, many potential move-up buyers find themselves outbid in multiple-offer situations amid a short supply of listings. As a result, they aren’t putting their current home on the market,” he stated. “It’s something of a vicious circle from the standpoint of a supply shortage and a challenge for first-time and move-up buyers alike.”

CREA reports that prices for two-storey homes saw the greatest year-over-year gains at 17.9%, townhouse prices rose 16%, one-storey homes by 15%, and apartment units by 13.7%. The average national sale price is now $519,521, and would be only $369,728 without the Vancouver and Toronto markets factored in.

About Penelope Graham

Penelope Graham is the Managing Editor at Zoocasa. A born-and-bred Torontonian and quintessential millennial, she has over a decade of experience covering real estate, lifestyle and personal finance topics. When not keeping an eye on Toronto's hot housing market, she can be found brunching in one of the city's many vibrant neighbourhoods. Find her on Twitter at @pjeg14.

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