What the Latest Bank of Canada Announcement Really Means for Your Mortgage
Last week, Canadians were left shocked by the raise of the overnight rate by 100 basis points, 25 more points than anticipated by industry leaders and specialists alike. Although it was not what was expected, it was what we were dealt. This has left most of us wondering, “Why?”
Why did the Bank of Canada drastically increase its overnight rate?
What experts believe is that this extreme rate hike was due to the expectations of inflation over the next few years among Canadian consumers and business owners. Consumers believe that within the next year, inflation will reach around 7%, then moderate slightly to 5% in two years’ time. Businesses believe that inflation will reach just shy of 5% in two years’ time. And finally, economists predict that inflation will reach only 2.5% in two years’ time. What this indicates is that consumers and businesses expect inflation to be much higher than what the BoC predicts. This poses problems for the Central Bank as history shows that this creates a cycle:
- Consumers expect prices to skyrocket
- Consumers demand a wage increase to counteract the higher cost of living
- Businesses begin to pay employees a higher wage to address demand but must raise their costs to make up for the lost revenue in wages
- Prices increase across the board and the cycle repeats
The Bank of Canada is attempting to battle these expectations through strategic overnight rate increases. Although economists do not seem as unsettled by inflation, both consumers and businesses are. The Bank of Canada must act now or else we will likely see higher policy rates down the road. Therefore, we are seeing an aggressive 1% hike as a strong attempt to temper consumer expectations.
In simpler terms: the rate goes up, spending goes down, supply matches demand, and inflation stabilizes.
How did we get here?
There are several factors that have caused inflation to be on the rise over the past year. Some of the most prominent being firstly, the prices of oil and commodities, which accounts for 40% of forecasting errors. The price increase in oil is due to Russia’s invasion of the Ukraine as well as several weather events that have affected agricultural commodities. Secondly, there was a major shift in buying patterns during the pandemic towards goods and low-contact services. This caused major issues to the supply chain as manufacturers couldn’t keep up with the excessive demand for goods. Thirdly, Canada recovered at a quicker rate than expected resulting from strong government intervention at the start of the pandemic. This had a large impact on the turnaround of the Canadian economy. And lastly, there were several references in the MPR around global factors accounting for over 60% of current inflation numbers, although the Bank of Canada only controls what is within our borders.
What does this mean for me, the borrower?
You might be wondering what all this information means and how it relates to you, the borrower. Despite negative headlines, the Bank of Canada is committed to bringing inflation down to the target range (2%-3%). This is not to say there won’t be more hurdles to jump through before we make it to that point. Fundamentally, Canada is and will continue to be in a strong position comparatively to other developed countries in terms of quantitative tightening.
If you are not already in a fixed rate mortgage, here are three option to consider moving forward:
- Status quo, stick with the variable rate you currently have
- Pro: Variable rates are still 1% cheaper on average than fixed rates currently. This provides you with more flexibility and your rate may move lower if we enter a recession.
- Con: Uncertainty around adjustable payments and trigger rates is stressful for those who seek security.
- Refinance or adjust
- Pro: There’s a chance you have some flexibility in your mortgage to extend the amortization, source a lower discount, move to a product with a capped payment, or even roll in additional debt payments to free up monthly cash flow.
- Con: There are added closing costs associated with refinancing in the form of registration fees and/or penalties.
- Convert to a fixed rate mortgage
- Pro: You can have peace of mind knowing what your rate and payments will be going forward.
- Con: There is the possibility that fixed rate mortgages are near the ceiling for the short-medium term. As the likelihood of a recession increases, the probability of fixed rates rising further decreases.
If you require further information or are unclear of what your options are as a borrower, reach out to one of our experienced Mortgage Specialist at Nest Mortgage Co. today.
