Variable mortgage rates set to rise with Bank of Canada poised to hike
Anticipation is building over whether the Bank of Canada will pull the trigger Wednesday on the first of several expected interest rate hikes this year. If it doesn’t, many will be looking for answers as to why the central bank hesitated and when liftoff will occur.
As of Monday morning, Bloomberg data indicated the market has priced in up to seven rate hikes by the end of the year, which would bring the overnight rate to 2.00 per cent.
The Bank of Canada’s key lending rate affects almost all aspects of life, whether it’s your personal finances, your investment portfolio, or the broader economy. Experts break down how they think key rate-sensitive areas will be affected.
The Bank of Canada has warned it would allow inflation to run hot for a period of time as the economy recovered from the COVID-19 pandemic - and individuals and businesses alike have felt the pinch.
But one rate increase will not tame inflation, according to Jennifer Lee, senior economist at BMO Capital Markets. She is expecting the bank to hike four times this year, starting in March.
“It’s going to take time, of course, for everything to factor through,” she said in an interview. “This will hopefully start to stem the very high rate of inflation that we’re seeing.”
As for the broader Canadian economy, Lee said higher rates will cause a pullback in growth, but is still forecasting gross domestic product will rise four per cent this year.
“[This year’s GDP forecast is] down from last year’s 4.5 per cent growth rate; but you don’t want anything to overheat, which is why the Bank of Canada should be raising rates right now, especially when you’re looking at the housing sector,” she said.
The timing on when a homeowner feels the squeeze of higher interest rates depends on whether they have a variable or fixed-rate loan.
“The impact on variable rates is direct in the sense that if the Bank of Canada moves up by 1.25 per cent, we should expect the prime lending rate to go up by that exact same amount. So the most obvious impact is on those who currently have a variable rate,” said James Laird, co-founder of rate comparison website Ratehub.ca, in an interview.
“They should expect their rate, and therefore their payment, to rise as the Bank of Canada rolls out interest rate increases.”
Meanwhile, homeowners with a fixed-rate mortgage will face higher rates when it comes time to refinance.
Laird wouldn’t necessarily tell homeowners that they should lock in their variable rate, but “it’s a consideration.”
“The variable rates that are available today or that people are already in are significantly lower than the fixed rates available today. So like always, variable rates start off cheaper – it does carry more risk and volatility but the variable rate has proven to be an excellent strategy for years and years,” he said.
Lastly, Laird has two pieces of advice for Canadians looking to buy a home in the coming months: Lock in a pre-approved mortgage rate while they’re shopping for a home and budget for higher interest rates in the future.
If higher borrowing rates are going to take some heat out of Canada’s housing markets, RBC Economics Senior Economist Robert Hogue said he thinks they will likely only have a marginal cooling effect.
He also said the impact probably won’t be felt until the second half of this year, since immigration and tight supply will continue to be dominant factors.
“We’re expecting a lot more newcomers looking for a home whether it’s rented or bought, so we’ll need more housing stock. Demand-side pressure may still persist. So at the end of the day, interest rate hikes could cool the market but there are other factors at play as well,” he said.
RBC Economics is forecasting three rate increases from the Bank of Canada in 2022 and another three next year.
In rural housing markets, Hogue said he thinks the shift to remote work and the search for affordability could offset some of the cooling effect from rising rates.
The impact of rate hikes on Canadian banks is twofold, says Bryden Teich, partner and portfolio manager at Avenue Investment Management.
While the banks would enjoy net interest margin expansion, the economic slowdown brought on by higher borrowing rates could work against them.
“When you look at where the banks are – at all-time highs – they’ve run up massively over the past two months,” Teich said. “I look at the banks and actually think much of the optimism of the rate hiking cycle is already being priced in.”
The rally now has him questioning whether they’re fully-valued.
“If I were to peek around the corner for the next 12 months, I think the hiking cycle that we’re going to start is going to slow the economy much faster than people think; so I’m starting to worry about recession risk over the next 12 to 18 months. With bank stocks at all-time highs, none of that is being priced in,” he said.
The formerly high-flying tech sector has been knocked down substantially over the past few months, primarily due to investors fleeing high-multiple stocks. A prime Canadian tech example would be Shopify Inc., which has seen its share price cut in half since its peak in mid-November.
“You have an environment where rates are rising, the really high-multiple tech stocks are going to be under pressure in that kind of environment, so it’s not surprising to see Shopify get hit so much,” Teich said.
However, with the drop in tech stocks, he thinks investors should get their shopping list out and start to build positions in quality tech firms.
“I would actually be lightening up on the banks and looking at companies in the tech space,” he said.
REAL ESTATE INVESTMENT TRUSTS
Similarly to what RBC’s Robert Hogue said of the housing market, Teich also doesn’t see higher interest rates becoming a major drag on real estate.
“I think we’re at the point in the cycle where raising rates off the bottom is not that damaging to real estate,” Teich said.
“The one place we’ve parked our investments on the REIT side is residential apartment REITs. We think the rental market is pretty attractive here and I think some of the Canadian apartment REITs are doing a really excellent job. That’s one side of the REIT spectrum where we own. The other side is something like [the grocery-anchored] Choice Properties REIT,” he said.
However, he warned that investors need to pick their spots in the REIT sector because he thinks some areas, such as the residential sector, are poised to fare better than the retail and office markets amid ongoing COVID-related uncertainty.
Typically, higher interest rates would mean a stronger Canadian dollar, but there are other factors – like U.S. monetary policy - at play that could lead to a weaker loonie by the end of the year, said Bipan Rai, North America head of FX strategy at CIBC Capital Markets.
With at least four rate hikes now priced in for the U.S. Fed this year, “it really does curtail any sort of topside pressure for the Canadian dollar,” he said.
He predicts the loonie will end 2022 at 77-cents U.S., while noting there will likely be a lot of volatility along the way.
“What I’m paying more attention to is not so much what interest rates do in 2022, but what we see beyond 2022 into 2023 and 2024,” Rai said.
“What we’re expecting there is that the market is going to be a little more aggressive to price in U.S. rate hikes for those years than from Canada – and that should weaken the Canadian dollar on balance in the second half of this year.”
One significant factor that would have upside risk to the loonie, he said, would be strengthening oil prices.