Why Canadians should brace for higher mortgage rates sooner than expected

The Bank of Canada took a step towards easing pandemic stimulus yesterday — the biggest yet by a major economy — with a hawkishness that surprised many observers.

Not only did it say it would reduce purchases of government debt (which was expected), it also brought forward its timeline for a possible rate hike.

Previously, the Bank had forecast that slack in the economy would not be absorbed until 2023. Now it expects that to happen some time in the second half of 2022.

The reason is a much brighter view of the economy. The Bank hiked its growth forecast for 2021 by more than two percentage points to 6.5%. It’s now predicting 3.7% in 2022 and 3.2% in 2023, an outlook rosier than many economists.

“The Bank of Canada has made a drastic U-turn in the space of three months from being extremely cautious to being extremely upbeat. While there’s still some ways to go until we get a move on rates, the Bank has taken the first step toward exiting QE, in what is clearly a more hawkish statement than markets anticipated,” BMO Economics Benjamin Reitzes wrote in a note after the announcement.

The news pushed bond yields higher and the Canadian dollar gained the most in almost a year.

There had been rumblings before this. Markets had already been pricing in a rate increase in 2022, with swaps trading suggesting a 50% chance of a hike by this time next year, Bloomberg reports. Almost three increases are fully priced in over the next two years, and five over the next three years.

A survey of Canadian economists done by Finder.com also found a shift in expectations.

In an earlier survey done in March, more than half of economists believed the rate would hold for two or more years. In the survey taken before the Bank of Canada decision Wednesday, 88% said they now believe the rate will only hold for two years or less, with more than half (54%) believing the rate will rise the second half of 2022.

James Laird, co-founder of Ratehub.ca and president of CanWise Financial mortgage brokerage, said if Canada’s recovery proves even stronger, it is possible the bank could move up its timeline further and Canadians should brace for higher mortgage rates sooner than expected.

“Now is a good time for anyone currently holding a variable rate to consider locking into a fixed rate,” he said, as the positive outlook also means fixed rates should continue to rise through this year.

“Anyone shopping for a home should get a pre-approval which will hold today’s rates for up to 120 days and allow them to move quickly in the competitive spring market,” Laird said.

Not everyone, however, believes the bank will hike that quickly.

Stephen Brown of Capital Economics said that he remains skeptical that the bank can manage it before early 2023.

“While the Bank’s new forward guidance implies it will raise interest rates one quarter before we currently anticipate, we remain sceptical that it will do so if oil prices drop back in 2022 and if the Fed remains committed to keeping its own policy rate unchanged until late 2023, as we expect,” he wrote in a note yesterday.

And BofA Securities’ Carlos Capistran said if other central banks don’t follow suit the Bank of Canada could risk derailing the recovery through higher interest rates and a stronger Canadian dollar —  “without much upside, in our view.”

Bank Governor Tiff Macklem, himself, while speaking to reporters after yesterday’s decision, said there is no guarantee borrowing costs will rise even when the bank deems the economy is running at full capacity.

“What we do when those conditions are met, we’ll have to assess that at the time. There’s nothing mechanical,” he said, adding: “We’re looking for a full recovery, we’re not going to count our chickens before they’re hatched.”