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Stronger-than-expected Q1 GDP increases chance of rate hike

It seems Canada’s economy simply refuses to cool, as the latest Gross Domestic Product (GDP) numbers for Q1 reveal stubbornly robust growth.

According to the report from Statistics Canada, the Canadian economy rose by 3.1% in the period between January to March, compared to the same time frame last year. That well outstrips the agency’s own forecast of 2.5%, as well as the Bank of Canada’s 2.3% call. March GDP, meanwhile, was largely flat, up 0.2% for the month. StatCan also released its “flash estimate” for April, anticipating another 0.2% increase for the month.

An uptick in exports, which rose 2.4% – a significant increase from the meager 0.5% growth recorded in Q4 2022 – along with stronger household spending, were the main factors pushing GDP higher. StatCan reports households are spending more on goods (+1.5%) and services (+1.3%),with auto sales making up a considerable chunk (+7.8%). The softening housing market, however, continued to make a mark, with residential investment falling 14.6% – its fourth consecutive quarterly decline.

A June rate hike is looking more likely

The hotter-than-expected reading – along with April’s sizzling inflation print – has raised fresh expectations that the Bank of Canada may indeed be spurred to hike interest rates once again in its upcoming June 7 announcement.

As Desjardins Senior Director of Canadian Economics Randall Bartlett puts it, “This is just the latest data point reinforcing the strength of the Canadian economy, particularly the consumer. While we’ll get more information at next week’s rate announcement, we think today’s data substantially increases the odds of another rate hike.”

Douglas Porter, BMO’s Chief Economist and Managing Director of Economics, says that despite economic drags such as early May’s public sector strike and ongoing Alberta wildfires, GDP will continue to perform more strongly than expected into the current quarter. 

“Perhaps the biggest eye-opener in today's report was the flash estimate for April GDP at +0.2%, despite the public sector strike in the second half of the month,” he writes. “We estimate that the strike likely trimmed at least a couple of ticks from growth (albeit with a wide range of uncertainty). The main point is that there's more underlying momentum in the economy than anticipated, and we will be revising up our Q2 GDP forecast from what had been a small drop (-0.5% a.r.) to a small positive.”

“The run of sturdy data undoubtedly raises the odds that the Bank of Canada needs to go back to the well of rate hikes, and even puts some chance on a move as early as next week's policy decision. However, given the uncertain backdrop and the possibility that inflation took a big step down in May, the BoC could opt to remain patient for a bit longer and signal that it's open to hiking in July if the strength persists.”

Borrowers to be squeezed further

The Bank of Canada has held its trending setting Overnight Lending Rate at 4.5% in its last April and March announcements, after hiking it an historic eight times between March 2022 and January 2023, raising the cost of borrowing a whopping 4.25% over that time period. That’s driven the Prime Rate used by lenders to set their variable cost of borrowing up to 6.7%, and has also considerably increased the threshold for the mortgage stress test, with most borrowers now having to qualify in the 6.5 - 8% range.

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Variable-rate mortgage borrowers have been the hardest hit as their monthly payments have either soared, or they’ve hit their trigger rate; the point at which their payments no longer contribute to their principal mortgage debt.

The rapidly rising mortgage rate environment has drawn concern from a number of industry analysts and policymakers – the Financial System Report out last week from the Bank of Canada warns that nearly all mortgage borrowers renewing between 2025 - 2026 will be impacted by higher rates. Fixed-rate borrowers can expect payments to jump as much as 25%, the report states, while variable-rate borrowers on a fixed payment schedule could see their costs balloon by as much as 40% if they want to remain on the same amortization schedule.

An additional 0.25% rate increase from the BoC in June would raise the benchmark cost of borrowing to 4.75%, and the Prime Rate to 6.95%.

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