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Bank of Canada raises Target Overnight Rate to 4.5%

Buckle up, borrowers: the Bank of Canada has dished out one more rate increase, which means variable-rate mortgage and HELOC costs are set to rise.

The central bank hiked its trend-setting Overnight Lending Rate this morning by 0.25%, bringing the benchmark cost of borrowing to 4.5%. That’s the highest level since December 2007 and the eighth increase implemented since last March, marking the steepest pace of rate hikes since the late 1970s.

The good news is the Bank has strongly indicated this should be the last hike for a while, meaning variable rates will stabilize this year – as long as inflation falls in line, that is. 

“If economic developments evolve broadly in line with the MPR outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases,” reads the Bank’s announcement release. 

However, it was careful to not rule future hikes out entirely, stating, “Governing Council is prepared to increase the policy rate further if needed to return inflation to the 2% target, and remains resolute in its commitment to restoring price stability for Canadians.” 

James Laird, Co-CEO of and President of CanWise mortgage lender says today’s announcement and forward guidance is largely in line with what the market was expecting, and will set the stage for more predictable borrowing conditions this year.

“We can expect the Bank of Canada to now hold the key overnight rate throughout this year, unless they observe that we are not on track to get inflation down to 3% by the middle of 2023 and 2% in 2024,” he says. 

“At present, the Bank believes core inflation has peaked and will consistently move towards their targets this year and into 2024. If this happens, Canadians can expect rate holds and possibly rate drops in 2024.”

The Bank’s optimism that the worst of inflation may be behind us is key; after soaring to a 40-year high of 8.1% this summer, the December Consumer Price Index report revealed the headline measure has slowed to 6.3%, largely reflecting lower gas prices. As a result, the BoC expects CPI to fall to 3% by mid 2023 and to return to its target of 2% next year.

As such, today’s announcement truly marks a pivotal moment in the Bank’s inflation battle, setting the tone for the cost of borrowing in the months to come, and officially backing off its aggressive hiking mandate with a “wait and see” approach. Markets had widely anticipated this would be the case, pricing in today’s hike with a 70% likelihood earlier this week.

Of course, challenges to reign in inflation persist; the economy continues to run hotter than the Bank has forecasted, with global growth coming in 3.5% last year. In Canada, the labour market has had a stronger than expected showing, with unemployment remaining near historic lows, and businesses facing labour shortages. While a strong job market is positive for Canadian workers, it could bolster high inflation for longer.  Overall, the Bank estimates Canada’s economy grew by 3.6% in 2022, slightly stronger than was projected in October. Growth is expected to stall through the middle of 2023, picking up later in the year. The Bank then expects GDP growth of about 1% in 2023 and about 2% in 2024, largely in line with its October outlook.

However, worries of a recession continue to hover; as it generally takes six months or so for interest rate changes to filter their way through the economy, business and consumer activity will continue to slow as this latest round of hikes is absorbed.

An economic update written by RBC economists Craig Wright, Robert Hogue and Nathan Janzen, points to the impact the BoC’s hiking cycle has had thus far on spending and housing markets.

“The Canadian economy continues to inch closer to a recession in 2023. Early signs of easing inflation pressures are raising odds that the downturn will be ‘mild’ by historical standards,” they write. “Unemployment dropped to record lows (since at least 1976) over the summer and has edged up only slightly since. But headwinds from aggressive central bank interest rate hikes are gaining strength. Housing markets have already retrenched sharply since spring. And consumer spending is expected to soften further as high inflation and rising debt payments cut into purchasing power.”

What today’s rate announcement means for mortgage rates

Those who currently have variable mortgage rates will be immediately impacted, as the cost of variable borrowing is directly influenced by their lender’s Prime Rate, which takes its cue from the BoC. Borrowers with variable payments will see their monthly payment increase immediately, while those with fixed payments will see more of their money go toward interest costs rather than their principal mortgage balance.

Let’s take a look at how today’s announcement will impact payments:

According to's mortgage payment calculator, a homeowner who put a 10% down payment on a $626,318* home with a five-year variable mortgage rate of 5.30% amortized over 25 years (total mortgage amount of: $581,160) has a monthly mortgage payment of $3,480.

With today’s 25-basis point rate increase, the homeowner’s variable mortgage rate will increase to 5.55% and their monthly payment will increase to $3,564.

This means that the homeowner will pay $84 more per month or $1,008 per year on their mortgage payments.

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“Anyone who currently has a variable-rate mortgage or home equity line of credit (HELOC) will see their rate increase by a quarter point, bringing the sum of their total rate increases in the last 12 months to 4.25%,” says Laird. 

“The good news is that they can expect the rate hikes to pause and possibly be over as long as inflation tracks in the right direction. With this latest rate hike, more Canadians have reached their trigger rate, which means their existing mortgage payment is no longer covering their monthly interest.”

Fixed mortgage rates are not directly influenced by the Bank of Canada, but today’s announcement could cause fluctuations in the bond market, which lenders use to set their fixed cost of borrowing. That’s because when interest rates rise, so too do bond yields, as existing investments are devalued. However, the Bank’s messaging that there’s stability to come will likely be positive for the bond market; Government of Canada five-year yields have been trending lower in recent weeks, which have given some lenders the flexibility to lower their five-year fixed rates slightly, a trend likely to play out if economic factors remain consistent.

The impact on the housing market

The Bank of Canada’s hiking cycle has had a material impact on the housing market over the last year; the December data from the Canadian Real Estate Association reveals sales are down -39.1% on an annual basis, while the average home price fell -12% year over year to $626,318. Both metrics are considerably off from where they were last February, which is now known to be the housing market’s peak; sales are down 59.5%, and prices -23.3%, a difference of $190,402.

CREA expects 2023 to mark the “start of a turnaround” for the market given anticipated interest rate stabilization – but a recovery is still a ways off given mortgage costs are historically elevated and affordability conditions are the worst they’ve been in decades. According to an updated forecast released by the national association, home sales are expected to remain flat this year at a -0.5% decline before picking up in 2024 with a 10.2% increase. Prices, meanwhile, will soften another -5.9% this year to an average of $662,103, before rising 3.5% to $685,056 next year, which puts it back on par with 2021 levels.

Today’s hike could lead to slower market conditions persisting further into the spring than they otherwise would as borrowers must absorb this latest hit to affordability. Sellers will likely be hesitant to list as this anticipated latest dip in demand plays out. 

“Today’s announcement should mean the floor for home values across the country is near. Home values might drift higher as long as the key overnight rate has peaked,” Laird adds.

The bottom line

While mortgage costs remain high compared to recent years, borrowers will see their options improve in 2023 – but whether or not they should lock in depends largely on their own financial situation, and where they believe the economy is headed.

“Anyone shopping for a fixed-rate mortgage this year can expect rates to continue to decrease as long as inflation numbers track the Bank’s targets,” says Laird. 

“Anyone who currently requires a mortgage who believes the Bank is finished hiking rates and anticipates rates dropping late this year or early next year, should consider a variable-rate mortgage because they will decrease if rates do come down. Canadians who think inflation is going to be more persistent than the Bank is expecting, should lock into a five-year fixed mortgage rate since rates will move up if inflation is more stubborn than anticipated.”   

Those currently shopping for a mortgage can also connect with a mortgage broker, who can help them assess their options in today’s evolving rate environment.

*December 2022 average home price in Canada was $626,318 (CREA)

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