Get Ready: Interest Rates Could Rise Even Faster and Higher Than We Thought


When the Bank of Canada raised its benchmark interest rate for the first time in two years earlier this month, it sent a clear message to borrowers that the era of cheap money was coming to an end. end.

With economists expecting the bank to gradually hike its rate half a dozen times this year, there is growing sentiment that the bank may need to start moving faster and more drastically than expected to contain inflation, which is already at its highest level. in one generation.

Pricing of investments known as swaps suggests there is a good chance the bank will raise its rate by half a percentage point at its meeting in April, taking the benchmark rate to 1%.

In central banks, caution is a virtue, so they tend to like to go up and down slowly, in increments of 25 points, or a quarter of a percentage point at a time. Moving half a percentage point at a time is a sign that the bank might think more aggressive action is needed.

The bank’s deputy governor said as much during a speech in San Francisco this weektelling attendees at a monetary policy conference that a slight increase in household debt was “worrying” and that the bank was “prepared to act forcefully” to ensure inflation was not too high for too long.

“I expect the pace and magnitude of interest rate increases…to be an integral part of our deliberations in our next decision,” Sharon Kozicki said.

How much and how fast

For Carlos Capistrán, an economist at Bank of America, strong language like that of a central banker is a clear sign that “everything is on the table” when it comes to bringing down inflation.

This kind of tough talk is the banks’ way of saying “We’re really going to fight this hard if we need to,” Capistrán says.

That’s why he’s increased his rate forecast since Kozicki’s speech, to include not just one but three big hikes in quick succession. He now expects the central bank to rise by 50 points at each of its next three meetings in April, June and July, and will follow them with smaller ones thereafter until next year until the rate of discount is 3.25%.

This is almost double the bank rate of 1.75% before the pandemic, and you would have to go back to 2008, before the financial crisis, to find the last time the rate was this high.

For Capistrán, the reasons to speed things up are obvious. “Inflation is quite high, the economy is really hot, the labor market is really hot in Canada and the [U.S.] The Fed is also about to hike 50 basis points,” he said in an interview. “So there are a lot of reasons why they might be more aggressive than usual this time around. .”

The Bank of Canada has made it clear that it will raise its benchmark interest rate over the next few months. But exactly how often and what is the million dollar question for borrowers. (David Kawai/Bloomberg)

Fixed rate loans are not immune

Aggression may be what is needed right now, but borrowers risk being collateral damage in the central bank’s nascent inflationary fight.

Floating-rate loans are pegged to the central bank rate, and they have risen slightly in recent weeks, ahead of the bank’s decision.

Fixed rate loans, on the other hand, are not impacted by the central bank rate and are instead priced according to what is happening in the bond market, but here too the market has shown warning signs. red last month: rates heading higher, fast.

When borrowers take out a loan from a bank, they may assume that the lender has this type of money, but in fact they are borrowing it from the bond market and making a profit on the spread between the rate they pay to borrow money for themselves, and the rate they charge their customers when they lend it out in things like mortgages.

A good number of borrowers are opting for five-year fixed-rate loans, which makes five-year Government of Canada bonds the best indicator of what might happen to fixed-rate loans, and the yield on that debt has jumped more than one percent in March – an unprecedented jump in the stuffy world of bonds.

The yield on five-year bonds rose above 2.5% for the first time since the pandemic this week, pushing fixed mortgage rates well above 3% or even 4% in response.

According to the Bank of Canada, the average rate for a conventional mortgage at the major banks is currently 4.79%. But remember, just a year ago, at the height of the pandemic, a borrower could get a five-year fixed rate loan for the first time ever at less than 1%.

According to rate comparison websites rates.ca and ratehub.ca, it’s not hard to find a variable rate loan right now for just over 1%, but if Capistrán’s projections are accurate and the Bank of Canada rate is heading towards 3.25, expect variable rates to make a similar jump.

The impact could be dramatic. Currently, a 25-year uninsured mortgage of $400,000 at 1.5% would cost $1,599 per month. But if that variable rate goes up to just 4%, when fixed rate loans already are, the monthly payment jumps by more than $500 per month for the life of the loan.

WATCH | Many mortgage holders are already walking a thin line, according to a survey:

Most mortgage holders walk a thin line as rates rise: poll

An Angus Reid poll found that 58% of homeowners say the costs of owning a home are already crowding out other parts of their budget. 2:06

‘Soft landing’

That’s $500 less in every homeowner’s pocket to spend on other things, which is why the Bank of Canada is concerned. “Rising mortgage rates will weigh on their spending,” Kozicki said in his speech, “and if enough of them materially slow spending, it could affect the whole economy.”

Finding the right balance between controlling inflation without flipping the economy is the job of the central bank, and economists have a term for defining the best-case scenario.

“What the central bank is trying to do and what we’re all hoping for is what we call a soft landing,” Capistrán said. “To lower inflation without creating a recession.”

Andrew Husby, an economist at Bloomberg, said the so-called soft landing the bank is trying to achieve is made even more difficult by the bank’s longstanding preference to be cautious when it comes to rising. and lower rates.

“If you’re too predictable and too gradual and you’re doing it just to be gradual and not to adjust to economic conditions, that can be a problem and it can lead to more inflation,” he said in a statement. maintenance.

Ultimately, this stated predilection is why he’s not among those expecting a bigger-than-usual rate hike next week — a path he says should be good enough. to achieve its objective of reducing inflation over the long term.

“As we enter the second half of the year, we will see inflation start to come down,” he said. “Not as far as the bank would like, but at least in the right direction.”