The first of multiple rate hikes from the Bank of Canada is in the books and banks have already boosted their prime lending rates by 25 basis points to 2.7 per cent.
Now borrowers all want to know the same thing – where does this end?
Canada, and the world, is in largely uncharted territory. Not even our central bank knows how high prime rate could go, as its off-base forecasts clearly demonstrate.
The bank does say, however, that Canadians should feel confident that runaway inflation is only temporary – that it’ll get soaring prices under control. That might lead one to think we won’t see the roughly two percentage points of rate hikes that the market now expects.
But as flawed as market expectations may be, this is not the time to ignore them – not if you’re a borrower living paycheque to paycheque anyway.
Oil prices have exploded, reminiscent of 1970s oil shocks. Barring a quick reversal, the Russian invasion of Ukraine could precipitate more and/or faster hikes from the Bank of Canada.
And like surging interest rates, soaring oil is also a recession precursor. Rate-hike cycles usually end in recession anyway, let alone those following commodity price shocks.
That’s why financial markets, who are always forward-looking, are already pricing in an economic slowdown. Bond-market derivatives now suggest Canada’s key lending rate could peak and turn lower within 24 to 36 months.
Be careful with assumptions
Expectations of a slowing future economy don’t necessarily imply a mild rate-hike cycle. Inflation is “nothing like we have had in decades,” U.S. Federal Reserve chair Jerome Powell said Wednesday.
Indeed, it’s hazardous for any mortgagor with a tight budget and limited liquid assets to assume we won’t see more than 150 bps of rate tightening. (There are 100 basis points in a percentage point.)
I like to say our central bankers are firemen who’ve arrived late to an inflation fire. After the 1973 oil shock, central banks also took too long to tighten monetary policy. Inflation hit double-digits and the prime rate just about doubled. The 1970s were a different era with far less consumer leverage (among other things), but while history may not repeat this time, it could rhyme.
The Fed’s Mr. Powell reminded U.S. Congress on Wednesday, “the economy evolves in unexpected ways.” He admitted he can’t call a turn in inflation with confidence, despite repeatedly assuring it would be “transitory” in the early stages of the pandemic recovery.
So while some say even five rate hikes this year is “aggressive,” know that it’s not. Not with inflation more than 150 per cent above target and climbing. Not when our central bank is playing catch-up. Not as inflation expectations are surging along with commodity prices. Not as war threatens to disrupt supply further.
It’s a reasonable bet that the Bank of Canada will have to hike enough to take us into recession, to bring this bout of inflation under control. Knowing that, Canada’s yield curve may well invert either this year or next. Inversion occurs when longer-term rates fall below short-term rates and it’s a highly reliable recession signal.
Recessions ultimately result in lower mortgage rates. That’s why well-qualified borrowers shouldn’t overpay for a long-term fixed mortgage, despite the ominous inflation outlook.
And that’s despite the risk of stagflation. Stagflation occurs when inflation surges and GDP drops. To head off this nightmare economic scenario, our central bank could potentially be forced to hike more than the expected 200 bps.
Ultimately, however, high rates and high price levels should be self-limiting. It just might take a few years.
For now …
Most people should avoid rushing into fixed rates materially above 3 per cent, especially with lenders that have punitive prepayment penalties. The outlook just doesn’t justify it.
I say “most” people because mortgage term selection is first and foremost about risk mitigation. If you’re a mortgagor with a tight budget, tentative employment and/or few liquid assets, and/or you simply can’t handle the threat of higher-than-expected rates, bite the bullet and lock in at least some of your mortgage.
You don’t need to lock in all of it and you don’t need to pick a five-year term. Hybrid mortgages let you split borrowing between a fixed and a variable rate. You can borrow half in a fixed and half in a variable, for as low as 2.17 per cent combined (HSBC’s uninsured rate).
A few last tips
- Canada’s all-important five-year bond yield had its biggest plunge since 2011 this week. Some will wait to see whether fixed rates – which are tied to the five-year bond yield – fall, but I wouldn’t expect major improvement near-term.
- If you need to lock in within the next four months, do it before five-year bond yields run back to their February highs. (While we could see a minor dip in some fixed rates, the five-year yield is still on an uptrend.)
- If market projections prove true – a loose assumption – rate simulations suggest the most competitive standard variable mortgage would result in less interest paid over five years than locking into today’s best five-year fixed rate.
Rates in the accompanying table are as of Wednesday from providers that advertise rates online and lend in at least nine provinces. Insured rates apply to those buying with less than a 20-per-cent down payment or those switching a pre-existing insured mortgage to a new lender. Uninsured rates apply to refinances and purchases over $1-million and may include applicable lender rate premiums. For providers whose rates vary by province, their highest rate is shown.
Robert McLister is an interest rate analyst, mortgage strategist and columnist. You can follow him on Twitter at @RobMcLister.