The Bank of Canada (BoC) held its policy rate steady last week, as expected.
The Bank’s accompanying communications offered a decidedly dovish assessment of our current economic backdrop.
In his Press Conference Opening Statement, BoC Governor Macklem candidly assessed that our economy is “dealing with a lot”. He noted slower growth, “weak” housing markets, a “soft” labour market, and “volatile” trade that has led to weakness in exports.
These trends were evident before the start of the Iran war. Then, once it began, the Bank expanded its list of the economy’s headwinds to include higher energy prices (which squeeze consumers) and tightening financial conditions (which comprise higher bond yields, lower stock prices, and wider credit spreads).
Governor Macklem also observed that inflation has “eased further”, noting that our Consumer Price Index (CPI) is now down to 1.8% and that the BoC’s key gauges of core inflation “are all now close to 2%”.
His logical conclusion was that, relative to the Bank’s January forecast, “risks to economic growth are titled to the downside”.
The Bank’s assessment of our domestic backdrop supported my contrarian call that we will likely see additional policy-rate cuts ahead. But events occurring beyond our borders also have an impact, and at this point, our deflationary domestic momentum is being counterbalanced by the inflationary threat from spiking oil prices.
Bond-market investors, who tend to shoot first and ask questions later, hold a more hawkish assessment.
They are now pricing in three BoC rate hikes this year with the first one expected in July. That is despite BoC Governor Macklem saying that he doesn’t think the bank will be compelled to start hiking in the near term (as he confirmed at the 25:30 mark of his press conference.)
Investors have reason to be nervous.
The International Energy Agency recently published a report warning that the closure of the Strait of Hormuz has triggered “the largest supply disruption in the history of the global oil market” and calling the current crisis “the greatest global energy security threat in history”. It highlighted the risk that damage to oil and gas infrastructure will prolong the energy sector’s post-war recovery and exacerbate its negative impacts.
Notwithstanding that dire warning, when uncertainty is high, history can be a sobering guide. Economist David Rosenberg recently noted that past energy crises haven’t typically caused the kind of inflation spike that bond-market investors now fear.
He observed that US core inflation has either stayed the same, or eased, during six of the last ten oil-price spikes, which stretch back more than forty years. He added that the biggest surge in core inflation tied to an oil-price spike was limited to 0.80%. It occurred around Gulf War 1 and was manageable at the time (despite extensive damage to oil and gas infrastructure).
Until we have better ideas of how long the Iran war will last and what its long-term impact on energy prices will be, I expect the BoC to hold steady.
It is also important to remember that today’s spiking oil prices are more an indication of what bond-market investors fear may happen, and less a reflection of what has happened thus far.
The Latest on Mortgage Rates
Government of Canada (GoC) bond yields surged higher last week, pulled higher again by rising US Treasury yields and spiking oil prices.
For reference, the five-year GoC bond yield, which is considered the benchmark for fixed mortgage rates, surged higher by another 0.30% last week. It has now increased by more than 0.50% in the past three weeks.
Lenders responded by raising their fixed rates. We will likely see that continue this week.
Variable-rate discounts are unchanged thus far.
The BoC is likely to remain on hold until some of the current fog clears, and it has increased latitude to be patient now that inflation has returned to its 2% target.
For my part, I still expect the Bank’s next move to be a cut, which it will enact to help cushion the blow from the economic damage currently being wrought by trade uncertainty and war.
My Take on Today’s Mortgage Options
Fixed rates continue to surge higher. Anyone who is actively looking to purchase within the next 120 days should lock in a pre-approval rate now.
Three- and five-year fixed rates remain the most popular choices. For as long as the spread between these two options is minimal, I think five-year fixed rates offer better value.
The relative appeal of variable rates has increased now that spiking bond yields are putting significant near-term pressure on our fixed mortgage rates.
I continue to expect variable mortgage rates to produce the lowest borrowing cost over their full terms, although I admittedly have less confidence in that view than I did before the start of the US/Iran war.
BoC Governor Macklem confirmed that the Bank will look through the oil-price spike over the near term. But if the war drags on and the inflationary impact from higher oil prices becomes more entrenched, there will come a time when the Bank must tighten. For now, my best guess (and hope) is that we won’t get to that point.
Important note: Anyone choosing a variable rate should do so only if they are comfortable with its inherent potential for volatility. Borrowers must also have the financial capacity to withstand higher costs (and in some cases, higher payments).
Insider’s Tip for Borrowers
Did you know that borrowers who put down less than 20% of the purchase price of a property get the best rates?
If that doesn’t makes sense to you, it will after you read this post.
Three Posts Every New Visitor to My Blog Should Read
1. Should Canadians Choose a Fixed or Variable Mortgage Rate During a Trade War?
This post provides a detailed comparison of the pros and cons of fixed- and variable-rate mortgages amidst trade-related economic uncertainty.
2. What Every Canadian Borrower Needs to Know About Fixed-Rate Mortgage Penalties
For myriad reasons, some of them unanticipated, many Canadians end up having to break their fixed-rate mortgages. This post provides a detailed breakdown of the very different ways that lenders calculate their fixed-rate mortgage penalties. The amounts charged can vary significantly from lender to lender.
This post provides a detailed summary of the key terms and conditions to pay attention to in your mortgage contract. (They are not standard and can vary in important ways.)
David Larock is an independent full-time mortgage broker and industry insider who works with Canadian borrowers from coast to coast. David's posts appear on Mondays on this blog, Move Smartly, and on his blog, Integrated Mortgage Planners/blog.