Market Rate Forecast: No BoC hikes until at least 2023
BoC’s Headline Quote: “The Governing Council will hold the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2% inflation target is sustainably achieved. In our current projection, this does not happen until into 2023.”
BoC on the Economy: “…The Bank expects Canada’s economy to grow by almost 4% on average in 2021 and 2022.” (the most since 2007)
This is the first time the Bank has explicitly provided a year (2023) for its next potential rate hike.
Many will view this as a promise. It’s not. It’s a “projection” the Bank says, and still subject to change.
In essence, “It means that if you’re a household considering making a major purchase,” Governor Tiff Macklem says, “you can be confident that interest rates will be low for a long time.”
A second wave of COVID remains the biggest risk, yet the BoC sees 4% GDP growth for the next two years. Canada hasn’t seen that growth rate since 2007. Albeit, until GDP has made up the ground it lost since February (and then some), there is almost zero rate hike potential.
Over the next “number of weeks,” the BoC will reduce its bond buying from $5 billion to $4 billion. But, and this is a big “but,” more of its purchases will be 5-year bonds. That’s good news if you’re hoping for lower 5-year fixed rates (since the two are closely correlated).
The BoC owns about one in three government bonds. Its continued buying could be the #1 force keeping 5-year rates from rising materially through the first half of 2021.
Fun fact: “More than 1/4 of respondents to the Canadian Survey of Consumer Expectations in the third quarter of 2020 reported they would like to move to a larger or single-family home because of the pandemic.”—Monetary Policy Report
Macklem said the economic outlook would have to “dramatically” change to warrant negative rates. If the BoC does cut again (a low probability), it may not be a full quarter-point. The BoC could potentially drop rates 10 or 15 bps instead, as Australia is considering.
The Bank also updated its long-run estimate of Canada’s neutral rate, saying “We assess that the Canadian nominal neutral rate lies in a range between 1.75 and 2.75 percent…” That suggests the Bank thinks rates will eventually level out just two percentage points (give or take) above today’s rates. That projection is 50 basis points lower than the BoC’s April 2019 estimate. We’ll talk more on this in a separate story.
How to Play It
5-year fixed rates from fair-penalty lenders will continue appealing to most borrowers, for multiple reasons:
The best nationally available 5-year fixed and variable rates are currently just 5 bps apart. Insured 5-year fixed rates are below variable rates. Most consider a 5 bps rate premium peanuts for peace of mind, as they should.
Inflation risk in or before 2024 and 2025 is real, meaning the probabilities of rate increases by then are also real.
Even if the BoC dropped rates 25 bps, the cost of being wrong by choosing a 5-year fixed is modest ($245 of extra interest per year per $100,000 of mortgage).
Note: When we say “many” we mean more than usual—i.e., tens of thousands of borrowers in the next year. That’s still a small percentage of the 6 million mortgagor households in Canada.
One-year fixed rates have never been cheaper and can now be found for as low as 1.24% in AB, BC, NL, ON and PE.
That said, a 1-year term shaves just 16 +/- bps off the best 5-year fixed or variable rates. Therefore, wanna-be rate timers should carefully consider whether that reward — $150/year in interest savings per $100,000 of mortgage — is worth the risk.