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What borrowers should know about the latest GDP numbers

Your mortgage news update for the week of August 4, 2023

Memo 1: Canadian May GDP comes in softer than expected

It appears tougher interest rates are starting to cycle their way through the economy, as the latest GDP numbers came in lower than expected – a development that could encourage the Bank of Canada to hold off on further rate hikes for the time being.

As reported by Statistics Canada, the Gross Domestic Product measure for the month of May rose 0.3% year over year; while higher than the 0.1% uptick recorded in April, that’s slightly below the 0.4% StatCan anticipated.

According to the data, GDP is on track to shrink further, with the June numbers anticipated to reveal a 0.2% contraction. Should that come to fruition, it would mean Q2 GDP growth would come in at 1 - 1.2% – down significantly from 3.4% growth in Q1, and also below the central bank's 1.5% forecast, as stated by its latest Monetary Policy Report.

The largest contributor to slowing growth was a significant decline in the oil and gas sector; while just over half of all industries posted some growth, energy’s -2.1% drop – the result of raging forest fires across the nation – was enough to pull down the deadline number. It was the first time growth in oil and gas has tumbled in five months, and marks its largest dip since August 2020, according to StatCan.

The pace of housing construction also chilled, as builders, grappling with higher borrowing costs, struggle to make development economics work in today’s interest rate environment. Residential construction fell by -1.8%.

However, not all analysts are convinced that the economy is truly cooling. Derek Holt, Vice President and Head of Capital Markets Economics at Scotiabank, wrote in a research note that the impact of wildfires, as well as the recent federal civil servants strike are among “various distortions” in the data, and that the economy could have tracked double the current growth rate if not for them, in turn keeping it in “excess demand conditions.” 

“What are the Bank of Canada implications? It’s challenging to control for serial shocks that are hitting the Canadian economy dating back to late last year and more recently including the Federal civil servants strike in April, wildfires over the past couple of months and then other disruptions such as the BC port strike,” he states in a research note. “The BoC’s job is to seek to control for these effects and craft monetary policy accordingly. In my view, such an exercise would be inclined to emphasize underlying resilience in the economy and to maintain a bias toward further tightening that will be informed by data.

“In short, it would be pretty silly of the central bank to drop its hike bias because of transitory shocks like strikes and forest fires!”

Memo 2: Bond yields push 4%, fixed rates move higher

Fixed mortgage rates have been steadily on the rise in recent days, as five-year government bond yields pushed past 4% last Thursday – an important psychological threshold for the market, and marking a 16-year high.

As lenders use bond yields to set the benchmark for their fixed mortgage rate pricing, the lowest option for a high-ratio borrower taking out a new five-year fixed-term mortgage today would be 5.19%. That’s soared 15 basis points overnight, as Canadian stock and credit markets reacted to a 0.25% rate hike from the US Fed on July 26. The Fed’s latest increase brings the American cost of borrowing to a 22-year high. In a press release following the announcement, Fed Chair Jerome Powell said the central bank will make rate decisions on a “data-driven basis” moving forward, reigniting investors’ fears that rates could indeed rise further in September.

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In a research note, Bank of Canada Chief Economist Doug Porter pointed out that the five-year yield has increased by more than a full percent since early May, and that this most recent uptick will squeeze homebuyers further.

“The back-up in five-year yields, along with recent BoC rate hikes, will throw a wet blanket on the nascent recovery in home sales and prices,” he stated.

Memo 3: Higher rates to stick around until 2025

Both fixed and variable mortgage rates have marched steadily higher in recent months, following volatility in the bond market, as well as the Bank of Canada’s militant 10-rate hike series. However, analysts seem to believe the worst of the rate pain is in the rear view, with the central bank to resume its rate hold until the end of 2023, and perhaps even start cutting rates again the latter half of 2024. 

However, according to a previous BoC head, this take may be altogether too rosy. In an interview with BNN Bloomberg, David Dodge, former BoC Governor and currently the senior advisor at Bennet Jones, said he believes te central bank will need to keep its benchmark rate on the higher side for at least two years in order for inflation to cool to its 2% target.

“It’s going to be a long period of what would be considered elevated interest rates,” he stated to the news outlet. “What it will require (disinflation) is continued— rather elevated— interest rates right through 2024, right into 2025.”

This is despite some early signs that the Bank’s aggressive hiking cycle are indeed taking hold; in addition to May’s softer GDP reading, inflation also came in at a promising 2.8% in June, down significantly from 3.4% the previous month. However, stickier core inflation of 3.9% (median), along with continuously high food and shelter cost measures will prevent the Bank from making too fast a move when it comes to rate cuts.

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