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Why a strong labour market might impact your mortgage rate

The Canadian labour market has been running hot over the last 12 months, as pandemic lockdowns have eased and the economy has roared back into force. The latest numbers from Statistics Canada show December was no exception – the national employment rate increased by 0.5% from November (reflecting an addition of 104,000 positions), marking a 3.7% increase for the whole of 2022 ( a total of 701,000 new hires).

As a result, the unemployment rate dipped by 0.1% to 5%, slightly ahead of its lowest-ever reading of 4.9%, seen in June and July of last year. This reflects just how much employment has rebounded since the early days of the pandemic; in May 2020, this measure sat at 13.7%, its highest since 1976.

However, while an abundance of jobs is certainly positive for Canadians, this isn’t entirely a good news story; sizzling employment could mean higher interest rates will stick around for longer, squeezing already tapped-out borrowers.

That’s because the Bank of Canada – the central bank that regulates the Canadian cost of borrowing – needs the economy to chill before it can take its foot off the rate-hike pedal. Simply put, a blazing-hot month for hiring isn’t helping the cause when it comes to taming inflation.

Already, economists are forecasting that this latest piece of data, combined with last month’s stronger-than-expected inflation report, increases the likelihood of another 0.25% rate hike from the Bank of Canada in its January 25th announcement. Such a move would bring the Overnight Lending Rate – the trend-setting rate that lenders use to set their Prime cost of borrowing – to 4.5%, a high not seen since July 2007.

In a research note, Desjardins Economics Principal Economist Marc Desormeaux says the December jobs release does “tilt the odds in favour of one final 25 [basis-point] rate hike from the Bank of Canada later this month,” emphasizing it was the seventh consecutive month where gains in hourly earnings for permanent employees exceeded 5%.

“Despite signs of slowing growth in other economic indicators, the apparent strength in hiring likely means the central bank’s job isn’t done just yet,” he writes. “In recent months, the governor has emphasized the need to rebalance the labour market if inflation is to normalize.” 

Desormeaux is referring to a speech made by Bank of Canada Governor Tiff Macklem in November, in which the central bank head said the persistently-low unemployment rate isn’t sustainable, and is a major contributor to stubbornly high inflation.

“The tightness in the labour market is a symptom of the general imbalance between demand and supply that is fueling inflation and hurting all Canadians,” Macklem stated at the time to an audience at Toronto Metropolitan University, pointing to the imbalance between demand for goods and services, and business owners’ struggles to find and retain staff.

Why does the Bank of Canada need to reduce inflation?

Like the labour market, the pace of inflation rebounded with a vengeance with the re-opening of the economy. Snarls in global supply chain logistics, which have created shortages for many of the goods Canadians consume, have been a major contributor, while geopolitical tensions, like the war in Ukraine, have put upward pressure on the oil and gas sector. That’s led to consumer price pain, whether at the grocery store or while filling up at the pump.

While real estate prices aren’t included in the “basket of goods” the consumer price index is based on, “shelter prices” – which include mortgage interest costs – are. According to StatCan, this measure rose 7.2% year over year in November, with mortgage interest costs rising by 14.5%. This is compared to 11.4% in October, the largest monthly increase since February 1983.

All of this has resulted in a November inflation reading of 6.8% – well above the 2% range the Bank of Canada strives to maintain. When inflation exceeds this target, the central bank reacts by increasing the Overnight Lending Rate. This is then directly reflected in the pricing of variable mortgage rates and other variable-based lending products, such as HELOCs.

A higher cost of borrowing in turn cools consumer and business spending, which then lowers inflation. The Bank of Canada has hiked its rate seven times since March of last year, bringing it from 0.25% to 4.25% today. That’s the highest this trend-setting rate has sat since December 2007, and the fastest pace of rate increases seen since the mid 90s. As a result, variable mortgage rates have soared: the best five-year variable mortgage rate today is 5.35%, compared to the record low 0.85% available last January.

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While fixed mortgage rates aren’t directly correlated to the Bank of Canada’s rate, they are influenced by the direction of its monetary policy via reaction in the bond market; a steady increase in bond yields over the course of 2022 have brought the best five-year fixed mortgage rates into the 4.5% range, up from the 2.34% available last January.

The Bank’s aggressive approach to rates has been partially successful – inflation has eased after hitting a 40-year high of 8.1% in June – but progress has been stubbornly slow. And, as long as economic indicators continue to come in stronger than expected, any potential rate relief is pushed further into the horizon.

The bottom line

Another 0.25% increase from the Bank of Canada at the end of this month would bring the benchmark cost of borrowing to 4.5%. That’ll be the steepest borrowing environment since July 2007, meaning borrowers will need to brace their budgets for the highest rates in 16 years.

Should rates move higher again, borrowers can expect to see five-year insured variable rates rise to the 5.6 - 6.7% range. Those planning on taking out a variable mortgage within the next couple of months can use Ratehub’s mortgage payment calculator to see how higher rates will impact their monthly debt servicing costs, as well as their overall home buying affordability. It’s also a great idea to get personalized advice in navigating today’s complex borrowing environment; connecting with a mortgage broker can help explain your options, at no cost.


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