The Bank of Canada (BoC) held its policy rate steady last week, as expected.
The Bank’s policy statement and accompanying communications cited two competing risks, which continue to roughly cancel each other out: the upside risk to inflation from higher energy prices and the downside risk to the economy from trade uncertainty.
Its next policy rate move will be determined by how these risks evolve.
If the US/Iran conflict continues and the Strait of Hormuz remains closed, energy prices, and the prices of other commodities that must transit the Strait, such as fertilizers, will remain elevated. Those higher prices may trigger broader cost-push inflation and may also raise inflation expectations to a level where accelerated demand adds to inflation pressure.
If some version of that scenario unfolds, BoC Governor Macklem warned, “there may be a need for consecutive increases in the policy rate”.
Thus far, however, the Bank doesn’t see signs of those pressures building.
It noted that there has been “limited evidence of broad-based pass-through of higher energy prices to other consumer prices. Measures of core inflation have moved down to around 2% and the share of CPI components growing above 3% is close to its historical average.”
If the Strait of Hormuz does re-open, the narrative will quickly shift back to the negative impacts that US trade uncertainty is having on our economy. And if we put the energy-price spike aside, the BoC’s assessment of our domestic economy makes a much more convincing case for policy-rate cuts than for hikes.
The Bank observed that our GDP was “weaker than expected”, “housing activity declined”, business investment “remained weak”, and employment was “little changed since the start of the year”. It also noted that our economy would “remain in excess supply” even after “some rebound in GDP growth”. Put more simply, our economy has plenty of capacity for non-inflationary growth.
For the time being, the BoC will remain in wait-and-see mode because “uncertainty is unusually elevated” and because inflation isn’t forcing its hand.
Going forward, the Bank reiterated its willingness to “cut the policy rate further to support economic growth” if the US imposes new trade restrictions but to also enact “consecutive increases” if higher energy prices lead to “ongoing generalized inflation”.
The BoC’s balancing act continues.
The Latest on Mortgage Rates
On balance, the BoC’s latest communications were less hawkish than bond-market investors were expecting. Government of Canada (GoC) bond yields fell after the Bank’s announcement.
The US Federal Reserve meets this week, and it will be interesting to see how Kevin Warsh, the newly appointed Fed Chair, balances rising inflation pressures with US President Trump’s oft-stated desire for rate cuts.
US bond-market investors have now completely priced out any rate cuts by the US Federal Reserve this year. Instead, they now expect one 0.25% Fed hike at its final meeting in December. We’ll soon see whether that scenario aligns with the new Fed Chair’s thinking.
Some lenders inched their fixed mortgage rates down a little last week, but rates remained range bound overall. The discounts offered on variable-rate mortgages were unchanged.
The bond market’s bets on the BoC’s near-term policy-rate path continue to be dialed back. Bond-market investors are now pricing in only one 0.25% hike by the BoC this year (down from three 0.25% hikes that were expected in early May).
My Take on Today’s Mortgage Options
Fixed rates are likely to remain volatile. Three- and five-year terms are the most popular choices. If the spread between those two options is minimal, I think five-year fixed rates offer better value.
Most of the borrowers I am working with right now are opting for the stability of fixed rates, and I certainly appreciate their appeal.
That said, I think variable rates are likely to prove cheaper over their full terms, especially now that spiking bond yields have put significant near-term pressure on fixed mortgage rates.
(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).
The BoC reiterated its willingness to look through the current inflation spike over the near-term last Wednesday, and our current inflation backdrop affords it the luxury to do that. But if the war drags on and its associated inflationary impacts become broader and more entrenched, there may come a time when the Bank is compelled to tighten.
For now, my assessment is that we won’t get to that point. But so much depends on how long the US/Iran war will last, if/when the Strait of Hormuz will re-open, and whether it stays open.
On that note, last week US President Trump announced, for the 38th time, that a US-Iran deal was close to completion. (Here’s hoping the 38th time is a charm.)
Insider’s Tip for Borrowers
Does the payment frequency you choose have much impact on your mortgage?
The correct answer might surprise you.
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.
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.