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Bay Street analysts call for a Bank of Canada rate cut by the end of 2023

In recent weeks, borrowers have been given a glimpse of hope that the rate hikes they’ve endured over the past year are finally coming to an end.

In its last monetary policy announcement on January 25th, the Bank of Canada made a – potentially final – 0.25% increase to its Overnight Lending Rate, stating it would take a “conditional pause” for the remainder of the year… as long as inflation plays along, that is.

This was music to mortgage holders’ ears; those with variable-rate mortgages have had to absorb a 4.25% increase in the space of 10 months, the steepest rate hike pace in decades. For those with variable payments, that’s led to spiking monthly mortgage costs, while those with fixed payments have found themselves hitting, or coming close to, their trigger rate.

And those with fixed-rate mortgages haven’t been spared either; while being locked in means many have dodged the volatility of a rising rate environment, soaring bond yields over the past year could very well likely mean considerable rate pain at renewal time. 

The Bank of Canada is certainly putting the message out there that, after the economic valleys and peaks of the pandemic, 2023 should be a year for rate stabilization. Markets initially reacted favourably to their more dovish take, with bond yields dipping in the immediate aftermath; some lenders even went as far as to moderately discount their fixed rates last week.

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A similar announcement that the US Federal Reserve – the BoC’s American counterpart – would pivot to a rate hold strategy seemed to seal the deal that rate relief is on the way. 

Strong labour numbers raise rate hold doubts

But economic sentiment can turn on a dime, and the latest slew of labour reports have raised doubts that the economy – and inflation – is sufficiently cooling. 

Last week’s news that US payrolls added 517,000 positions in January – far above the forecasted 185,000 – threw markets into a tizzy and re-fuelled fears that the economy would run persistently hot, forcing the Fed to continue its rate hiking trajectory. Canada’s jobs report, out today, has also smashed forecasts with 150,000 positions added to the economy, keeping the unemployment rate at 5%. Five-year government bond yields have been steadily rising on the news (3.27% as of publish time), which could lead lenders to increase fixed rates once more in the coming days.

However, RBC Economist Carrie Freestone doesn't think hot labour numbers will move the dial on the BoC's rate hold stance. In an economic update she writes,  "Job postings are still up 50% from pre-pandemic levels, but have come down in recent months. It remains our view that labour markets will not remain this tight over the near term. The delayed impact of the Bank of Canada’s 425 basis points of hikes are still gradually flowing through to household and business debt payments and will ultimately erode demand, pushing unemployment higher through the end of the year."

However, if the next few months prove persistent job strength, that could raise risks of another hike later on.

"The Bank of Canada has indicated that rates will be held steady unless there is sufficient evidence that more restrictive monetary policy is needed. While the BoC will likely look past one strong jobs report, if additional reports prove to be stronger than expected, this would pose upside risk to the current terminal rate forecast of 4.50%," she writes.

Bay Street is calling for a rate cut

Contrary to concerns whether central banks will need to hike for longer, representatives from Canada’s main financial institutions are actually flipping the narrative, pointing to an impending recession that could force the BoC to loosen monetary policy sooner than it’s letting on.

These findings were apparent in the first ever Market Participants Survey results released this week by the BoC, which are gathered from 30 financial analyst respondents over the last quarter of 2022.

These bankers aren’t afraid to say a cut is in the cards; according to the median estimate of their forecasts, 28 of the 30 respondents believe the BoC’s Overnight Lending Rate will remain unchanged throughout July, before being cut to 4% by the end of 2023. The 75th percentile of respondents also call for inflation to hit 3.4% by end of the year, before moderating to 2.4% next.

But, upward risks persist – 77% of respondents noted Canada’s “output gap” – the difference between what the economy is currently producing, and what the BoC forecasts it can deliver before impacting inflation – is positive, meaning conditions are still running too hot to effectively dampen inflation.

BoC top brass says a cut’s not on the table – for now

Despite this take, the Bank of Canada Governor has refused to entertain the possibility of a cut, doubling down on his intent to stabilize rates. In a speech given this week to CFA Quebec, Tiff Macklem acknowledged that the economy is seeing some impact from the “forceful” rate hikes made over the last year. Signs are emerging that spending has declined, the job market is cooling, and that inflation is falling due to lower demand.

“Monetary policy doesn’t work as quickly or painlessly as everyone would like, but it works,” he stated. “And it will be worth it when Canadians can once again count on low, stable and predictable inflation.”

However, it takes time for the full impact of rate hikes to be felt, and Macklem made it clear the BoC is now in wait-and-see mode to see how its rapid rate increase mandate will trickle through the economy.

“This pause is conditional: it depends on whether the economy develops as we think it will and whether inflation continues to fall,” he added, reiterating that the Bank expects inflation to drop to 3% by the middle of this year and reach its 2% target next.

“If new evidence begins to accumulate that inflation is not declining in line with our forecast, we are prepared to raise our policy rate further.”

New BoC Summary Deliberations shed new light on rate decision

In another first for the BoC this week, it released a summary of the deliberations behind its January 25th announcement, offering new context into its decision to hike rates again by 0.25%, and stating it would hold moving forward.

In fact, it appears the Governing Council heavily considered whether or not to hike rates at all in December, given inflation and the economy appeared to be heading in the right direction. The rationale behind the 25-basis-point hike ultimately came down to a stronger-than-expected labour market and third-quarter GDP growth. One last hike would help “insure” excess demand in the economy would continue to ease, and prevent inflation from getting “stuck somewhere above 2% later in the projection.”

The high debt loads carried by today’s borrowers were also a deciding factor as the Bank considered that many households with five-year mortgage terms would be renewing over the coming year or so.

“In many cases, they would be facing significantly higher monthly mortgage payments, and this could reduce other spending by more than expected,” states the BoC’s summary. “Higher interest rates would also encourage more savings. And members noted that consumer confidence measures had weakened, indicating households may put off major purchases.”

The bottom line

Whether or not the Bank of Canada strays or sticks to its current rate hold commitment, one thing is clear: mortgage rates will remain elevated for the foreseeable future, contributing to some of the toughest home affordability conditions seen in years.

The BoC believes the impact of their rate hikes will be felt through the housing market could be felt for the long term, especially if home prices continue to decelerate at the same pace. However, this could be countered by more buyers entering the market under the belief that rates will soon ease up. Borrowers and analysts alike will be watching the Bank of Canada’s next rate announcement – scheduled for March 8, 2023 – keenly for future insights.

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