Why the Canadian Home Expects Bank of Canada To Hold Policy Rate Steady at 5%?

In recent months, the Canadian economic landscape has been anything but predictable. The Bank of Canada's decision regarding the policy rate has been under the spotlight, and at The Canadian Home, we anticipate that they will hold the rate steady at 5% in the upcoming announcement on October 25th, 2023. Today, we will delve into the key factors that are shaping our outlook.

The Findings of Business Outlook Survey - Third Quarter Of 2023

Every four months, the Bank of Canada surveys 100 different companies. This helps them gather important information to carry out their responsibilities as Canada's central bank. On October 16th, 2023, BoC released the results of this survey for the third quarter of 2023. These findings also revealed the impact of the recent rigorous rate hikes on the housing market.

1The Impact has broadened compared to 2022

The increases in interest rates have had a significant impact on the economy, with a majority of respondents saying that they have been worse off as a result. This is because their monthly mortgage payments have increased significantly. Variable-rate mortgage holders have been impacted the most while renters and fixed-rate mortgage holders are not far behind.

In the fourth quarter of 2022, 42% of respondents said that they had been worse off as a result of higher interest rates while in the third quarter of 2023, this number has now increased to 53%. This indicates that Canadians are still feeling the effects of the increased interest rates, and it's probable that these effects will persist, negatively affecting the economy in the upcoming months. The situation could deteriorate if the rates aren't kept stable.

2Mortgage payments are stretched to the limit

As you can see a significant portion of homeowners' monthly mortgage payments are close to or beyond the maximum they can afford. This is concerning because it means that these homeowners are at risk of financial hardship if their financial situation changes, such as if they lose their job, have a medical emergency or the rates rise further.

If for the sake of the argument we ignore the ones who are far below the maximum affordable mortgage payment then roughly 46% of all homeowners are almost stretched to the limit.

The Inflation Angle

Canada's annual inflation rate took everyone by surprise as it unexpectedly slowed to 3.8% in September, contrary to the 4.0% expectation. Even the month-over-month consumer price index experienced a decline of 0.1%. This deceleration has led to reduced expectations for an interest rate hike by the Bank of Canada.

Two of the Bank of Canada's core measures of underlying inflation also showed signs of slowing down, further strengthening the case for maintaining the current policy rate. Money markets are now estimating only a 16% chance of a rate increase, down from 43% prior to the release of the inflation data. No wonder, the Canadian dollar weakened as a direct response to these figures.

Our Market Projections

There are a couple of takeaways from everything that has been said so far, first the housing market, mortgage holders and aspiring home buyers are still in the process of adjusting to the new rates. Second, inflation has gone down and although it is above the Bank of Canada's 2% target it is not at the worrisome 4% anymore. Moreover, as evident from the business outlook survey, businesses have grown increasingly pessimistic about the economic outlook. This directly influences the Bank of Canada's decision-making process. The central bank has raised rates to a 22-year high of 5%, which makes a strong case for pausing and allowing these previous rate hikes to have their intended effect before another rate hike could be considered.

Another factor that needs to be noted is the inverse relationship between Bond yields and Interest rates. In Canada, the interest rates on Canadian bonds of different durations were a bit mixed. Think of these interest rates as the cost of borrowing money for the Canadian government. The 10-year bond interest rate went up by 8.8 basis points to 4.195%. This is getting closer to the highest it has been in 16 years, which was 4.292%, and that happened earlier this month. It's like the cost of borrowing money for Canada is going up for 10 years and if the rates are not held steady then that will more than likely be the case.

This is why, The Canadian Home expects the Bank of Canada to maintain a stable 5% policy rate due to slowing inflation, market uncertainty, and housing market concerns. The central bank should weigh its decisions carefully, considering the impact on inflation and Canada's overall economy. We are eagerly awaiting their announcement and monitoring the economic situation for updates.