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Lower-than-expected GDP supports rate-hold plans

Your mortgage memo news for the week of April 28, 2023

Memo 1: Lower February GDP supports ongoing rate hold

It’s becoming more evident that the Bank of Canada’s spate of rate hikes are working their way through the economy, with the latest GDP numbers coming in lower than expected.

Statistics Canada reported on April 28 that real gross domestic product – an important indicator for the central bank – essentially stalled in February, rising just 0.1%. That follows a 0.6% in January, and comes in lower than the 0.3% expected by analysts. According to the national data agency, overall GDP rose a total of 2.5% in the first quarter of the year.

While there was growth in many areas – 12 of the 20 subsectors increased, says StatCan – plunging wholesale and retail trade and manufacturing were responsible for pulling the measure down. The below-average numbers are also likely to fall further given the current federal worker’s strike.

Softening GDP poses both pros and cons for consumers; while it points to a growing likelihood of a recession, it supports the Bank of Canada’s plan to hold off on further rate hikes for the time being – offering variable-rate mortgage holders some considerable relief.

However, according to RBC Chief Economist Nathan Janzen, it’s too soon for borrowers to count on rate cuts. 

“ With GDP growth tracking weak momentum into Q2, the BoC isn't expected to hike interest rates again,” he writes in a daily economic update note. “Although inflation is also still too firm to justify a quick shift to cuts, even with the economy showing signs of softening.”

Memo 2: Mortgage insurers sound the alarm on underwater loans

It’s been a tough year for anyone who’s recently purchased a home. Following an enormous run-up in prices over the course of the pandemic, home values have rapidly tumbled in the last 12 months, as the Bank of Canada’s rate hiking cycle has greatly eroded buying power and affordability. According to the March data from the Canadian Real Estate Association, the national average home price remained nearly 14% below last year’s levels.

That’s had a drastic impact on homeowners’ equity, and has inflated the number of higher-risk mortgage loans in Canada, according to the national housing agency. 

The Canada Mortgage and Housing Corporation (CMHC) said in a report this week that the proportion of borrowers with a loan-to-value ratio (the amount owed on their mortgage compared to the actual value of their home) above 95% more than doubled in the third quarter of 2022, accounting for an insured mortgage balance of $5 billion.

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Generally, the higher a borrower’s LTV, the more risk they pose as a borrower, given they owe an outsized amount compared to their equity. In Canada, borrowers must make a minimum down payment of 5% on their home purchase, and are required to have mortgage default insurance – which the CMHC is a provider of – for purchases with less than 20% down. However, dropping home values have eaten up what little equity these high-ratio borrowers had to begin with, leaving the national agency holding an increasingly riskier bag.

And the CMHC isn’t the only one reporting these ballooning risk numbers. The other two default insurance providers in Canada – Sagen and Canada Guaranty – have also indicated they’re insuring a considerably higher number of these higher-LTV mortgages, with some even surpassing the 100% mark – meaning they’re officially “underwater”, with more owed on the home than it's worth.

Overall, the drop in home prices poses one of the biggest risks to the Canadian economy, says national banking regulator OSFI, which wrote in its Annual Risk Outlook, “The housing market changed substantially over the past year. Following record increases during the pandemic, house prices declined significantly in 2022. OSFI is preparing for the possibility that the housing market will experience continued weakness throughout 2023.

The steep increase in interest rates has eroded debt affordability. This is a growing concern from a prudential perspective. Mortgage holders may not be able to afford continued increases on monthly payments or might see a significant payment shock at the time of their mortgage renewal, leading to higher default probabilities.”

Memo 3: The Bank of Canada was indeed considering an April rate hike

On Wednesday, the Bank of Canada released its “summary of deliberations” around its last interest rate announcement, providing additional insight behind its thought process on rate direction.

The summary reveals that while the governing council stuck with its rate-hold stance, a potential hike did come up for consideration, on fears that inflation isn’t slowing as quickly as the central bank would like.

The BoC has already increased its trend-setting overnight lending rate a historic eight times between March 2022 and January 2023, bringing it from a pandemic low of 0.25% to 4.5% today. An additional 0.25% hike would have brought the benchmark cost of borrowing to 4.75%, the Prime rate to 6.95%, and pushed variable mortgage rates – and resulting mortgage stress test criteria – even higher.

However, given this roundtable occurred a week before the latest inflation report – which showed CPI continued to slow in March, to 4.3% – it’s all the more likely that the central bank will continue to hold rates into the future, meaning borrowers can breathe (somewhat) easier. The BoC wants to see inflation fall to the 3% range by the end of 2023, before lowering to its 2% target by next year.

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