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Stubborn inflation fuels rate hike fears

Your Mortgage Memo news for the week of February 17, 2023

Memo 1: Stubborn inflation leads to more rate hike fears

Both the Bank of Canada and the US Federal Reserve have been trying to persuade markets and borrowers that their respective rate hiking cycles are coming to a close – but persistently strong economic data is failing to back that up.

Markets reacted sharply this week to the latest crop of American inflation numbers, which revealed the US Consumer Price Index rose 6.4% in January. While that’s the smallest gain in the last 18 months, analysts had hoped for a print of 6.2%. Following stronger-than-expected labour reports out last week both north and south of the border, doubts are rising that monetary policy makers will be able to avoid raising rates further, with markets pricing in a 50/50 chance the Fed will hike by another 0.25% in June.

Borrowers are already feeling the pain. Bond yields have soared in reaction to the latest data, pushing fixed mortgage rates higher across all terms. Today’s best five-year fixed mortgage rate (high ratio)  is now 4.59%, a 15-basis-point difference from the 4.44% available on February 10.

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However, there is hope that the inflation pressures plaguing the US will be less severe in Canada. A recent economic update note written by RBC economists Nathan Janzen and Claire Fan states that Canadian CPI – which will be announced next Tuesday, February 21st - should clock in at 6.1%, following December’s 6.3% reading. The economists forecast that shelter inflation – a part of the basket of foods used to gauge CPI growth – will have dropped given January’s weak real estate sales, which came in at a 14-year low.

“Stronger near-term momentum is clearly raising risks that central banks will hike interest rates more than previously expected this year,” they write. “But taken with slowing inflation and moderating wage growth, we don’t think there’s enough reason to alter that path just yet. Interest rate hikes will increasingly squeeze household purchasing power and slow demand. We continue to look for the Bank of Canada to hold rates at current levels, and the U.S. Fed to make one more move in March before pausing.”

Memo 2: The BoC remains committed to a rate hold

Take it from the head of the Bank of Canada himself – Canadian borrowers can count on variable rate stability, pending any nasty inflation surprises.

In remarks given Thursday to the House of Commons Standing Committee on Finance, BoC Governor Tiff Macklem said, “We know it takes time for higher interest rates to work through the economy to slow demand and reduce inflation… Guided by what we have seen so far and our outlook for economic growth and inflation, we think it is time to pause interest rate hikes and assess whether monetary policy is restrictive enough to return inflation to the 2% target.” 

He adds that as long as economic developments remain in line with the BoC’s forecast and inflation comes down as predicted, they won’t need to raise rates further. The BoC’s January outlook calls for close-to-zero economic growth for the first three quarters of this year - signaling a mild recession – which will be key in alleviating pressure on inflation growth.

Macklem also reiterated the BoC’s expectation that CPI will fall to 3% by the middle of this year before returning to its 2% target in 2024.

“We’ve already seen a momentum shift in goods prices,” Macklem stated. “For inflation to get back to 2%, the effects of higher interest rates need to work through the economy and restrain spending enough for supply to catch up. The tightness in the labour market needs to ease, wage growth needs to moderate, and service price inflation needs to cool. Inflation expectations also need to come down and businesses return to more normal pricing behaviour.”

Memo 3: Home prices have further to fall

Canadian housing prices have dipped considerably as interest rates have increased; the latest data from the Canadian Real Estate Association (CREA) found the average plunged -18.9% year over year in January to $612,204. Fewer buyers qualifying for mortgages at today’s elevated rates have chilled market demand, with sales down a whopping 37.1%, as affordability continues to worsen.

And, according to one economic think tank, the market has further to fall. A recent report from Oxford Economics is calling for the national home price to drop a full 30% from last year’s peak by the middle of 2023 – and that current market conditions are only halfway there.

In a worst-case scenario, the report states, prices could fall by a full 48%, with the best being a 27% dip, should inflation ease and mortgage rates lower.

This take is echoed by another analysis out this week from RBC Assistant Chief Economist Robert Hogue, who writes that while Canada’s market correction is likely in a “late stage,” he sees downward price pressure to continue in the next few months.

“The Bank of Canada’s 25 basis-point increase in its policy rate in January—the last hike this cycle in our opinion—will keep things challenging for buyers from coast to coast,” he writes. “We believe prices in BC have the biggest downside at this stage given the extremely poor affordability situation in the province, high sensitivity to interest rates and soft demand-supply conditions. Massive earlier gains in Ontario also leave plenty of room for prices to fall deeper in several markets, including the Greater Toronto Area, although we think most of the correction is behind us.”

The bottom line:

It continues to be a season of volatility for mortgage borrowers and homebuyers, as economic data continues to upend analysts’ expectations. All eyes will be on Canada’s upcoming inflation report for the clearest direction on where rates may be heading next. In the meantime, borrowers shopping for a fixed-rate mortgage can expect them to edge higher in the coming days, as the bond market remains highly reactive.

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