The Bank of Canada Slowed the Pace of Monetary Tightening

The Governing Council of the Bank of Canada (BOC) raised its target for the overnight policy rate by 0.50% today to 3.75% and signaled that the policy rate would rise further. Most market analysts had expected a 0.75% hike in response to the disappointing inflation data for September. Headline inflation has slowed from 8.1% to 6.9% over the past three months, primarily due to the fall in gasoline prices.

In his press conference, Governor Tiff Macklem said that the BOC chose to reduce today's rate hike from 0.75% last month (and 1.00% in July) to today's 0.50% because "there is evidence that the economy is slowing." When asked if this is a pivot from very big rate increases, Macklem said that further rate increases are coming, but how large they will be is data-dependent. Global factors will also influence future Bank of Canada actions.

The press release concluded with the following statement: "Given elevated inflation and inflation expectations, as well as ongoing demand pressures in the economy, the Governing Council expects that the policy interest rate will need to rise further. Future rate increases will be influenced by our assessments of how tighter monetary policy is working to slow demand, how supply challenges are resolving, and how inflation and inflation expectations are responding”.

Monetary Policy Report (MPR)

The Bank of Canada released its latest global and Canadian economies forecast in their October MPR. They have reduced their outlook across the board:

• GDP growth in 2022 has been revised down by about ¼ of a percentage point to around 3¼%. It has been reduced by close to 1 percentage point in 2023 and almost ½ of a percentage point in 2024, to about 1% and 2%, respectively.
• Consumer price index (CPI) inflation has been revised down by ¼ of a percentage point to just under 7% in 2022 and by ½ of a percentage point to about 4% in 2023. The outlook for inflation in 2024 is largely unchanged. The downward revisions are mainly due to lower gasoline prices and weaker demand.
• The Bank is expecting lower household spending growth. Consumer spending is expected to contract in Q4 of this year and through the first half of next year. Higher interest rates weigh on household spending, with housing and big-ticket items most affected (see chart below).

Decreasing house prices, financial wealth and consumer confidence also restrain household spending. Borrowing costs have risen sharply. The costs for those taking on a new mortgage are up. For example, a homeowner who signed a five-year fixed-rate mortgage in October 2017 would now be faced with a mortgage rate of 1½ to 2 percentage points higher at renewal.

Housing Market

Housing activity is the most interest-sensitive component of household spending. The rise in mortgage rates contributed to a sharp pullback in resales beginning in March. Resales have declined and are now below pre-pandemic levels (see chart below) and renovation activity has also weakened. The contraction in residential investment that began in the year's second quarter is projected to continue through the first half of 2023. House prices rose by just over 50% between February 2020 to February 2022 and have now declined by just under 10%. They are projected by the Bank of Canada to continue to decline, particularly in those markets that saw larger increases during the pandemic.

Bottom Line

The Bank of Canada's decision today to hike interest rates by 0.50%, which was 0.25% lower than what economists/markets forecasted, was not expected.

A 0.50% rate hike is still an aggressive move, and the implications are considerable for the housing market. The prime rate will now quickly rise to 5.95%, increasing the variable mortgage interest rate another 0.50%, which will likely take the mortgage-qualifying rate to roughly 7.5%.

We expect the Bank of Canada to raise rates again in December by 0.25% and once again in 2023. The overnight target rate will likely be 4.25% to 4.50% and the BOC will hold firm for the rest of 2023. Of course, this is data-dependent and the level of uncertainty is elevated.

info courtesy Simon Wong , Mortgage Professional with Dominion Lending .