How could 25% US tariffs impact Canadian mortgage rates?

On Saturday, February 1, Donald Trump signed the executive order making 25% import tariffs a reality for Canadian goods entering the United States, along with a 10% tariff on energy. Originally set to take effect on February 4th, the implementation of the tariffs has now been pushed back by 30 days.

The Canadian government has been swift to retaliate in kind to the tariffs, threatening to slap our own 25% increase on $30 billion-worth of American goods, to be expanded to $155 billion.

The potential impact on the Canadian economy has been well documented; a recession is all but a certainty, with economists calling for economic growth to pause for up to three years, and a drop in GDP between 3.4 - 4.2 points, compared to a non-tariff scenario. 

Such a decline in GDP would cost individual Canadians roughly $1,900 – and jobs are  also on the chopping block. An economic note written by RBC economists Frances Donald and Nathan Janzen says Canada’s unemployment rate could rise by two to three percentage points.

For those who are currently shopping for a mortgage rate, it’s hard to know how to proceed. The threat of large-scale job losses would certainly put borrowers in a vulnerable position, and could lead to mortgage defaults. When staring down the barrel of a recession, making a big financial commitment, such as buying a home, may not seem sound – but there are many Canadians who don’t have the luxury of timing the market, especially if they’re coming up for renewal on their existing mortgage term.

While there are still many questions – such as how long tariffs could last – that will influence the long-term outlook for the economy, there’s plenty at play impacting mortgage rates right now. Here’s what borrowers need to take into account.

Bond yields plunged, and fixed rates have dropped

The moment markets opened on February 3rd – their first session following the signing of Trump’s executive order – bond and treasury yields plummeted, as investors piled into “safe haven” investments rather than stocks, which experienced a selloff as growth fears solidified. The Government of Canada five-year bond yield – which lenders use as a pricing benchmark for five-year fixed mortgage rates – dropped to the 2.58% range. That’s a 14-basis-point decrease from the previous close, and a low not seen since April 13, 2022. In the US, the 10-year Treasury yield – which acts as a global benchmark for debt – also eased to 4.51%, from 4.55% late Friday.

This came after weeks of increasing yields, as those same investors priced in their worries over whether tariffs – and resulting inflation – would come to fruition.

As an immediate result, fixed mortgage rates have already started to come down, with the lowest five-year fixed mortgage in Canada now at 3.89%. How long yields will stay low remains to be seen – by the morning of the 4th, yields had already ticked back up to the 2.75% range as the 30-day extension lends markets confidence.

As well, investors will eventually need to take into account the inflationary pressures caused by tariffs, especially if they’re here long term. If you’re currently shopping for a mortgage rate, it’s important to strike while yields are still trending lower, and secure a rate hold and pre-approval to guarantee access to the fixed-rate pricing that’s available today, before markets shift again.

An even lower rate from the Bank of Canada?

Before tariff threats became reality, the BoC was on a fairly straightforward path. With inflation happily back to its 2% target range, and with economic growth poised to perk up, the central bank intended to reduce the pace and size of rate cuts in 2025, potentially passing on two to three cuts to bring the overnight lending rate – the pricing underpin for variable-rate mortgages – to around 2.5 - 2.75%.

Tariffs have thoroughly upended that outcome. In the case of a recession, the BoC will need to return to an aggressive cutting cadence to stimulate the economy, even if inflation starts to spike.

In an analysis titled “Trade War: First Pass”, BMO Chief Economist and Managing Director of Economics Douglas Porter writes, “Previously, we projected the Bank would cut the policy rate two more times this cycle, by 25 bps in April and July (ending at 2.50%). We now look for the quarter-point pace to continue each meeting until October, thus ending at 1.50%. The net risk is that we get to the endpoint sooner.”

The last time the BoC’s benchmark rate was 1.5% was back in June 2022; interest rates were on the rise to counter growing inflation, which rose as pandemic-era restrictions were being removed. However, variable mortgage rates were still very accommodative; the lowest five-year variable at the time was 2.5%, in comparison to the five-year fixed rate, which had already increased to the 3.5% range.

Either way, variable mortgage rates are set to continue their downward trajectory, and provide greater affordability for borrowers who are less risk averse.

The impact on inflation and the Canadian dollar

Tariffs will lead to rising inflation; not only will suppliers hike the cost of goods to counter higher import costs, but the various responses taken by Canadian policymakers will also be inflationary. 

First, the tariffs themselves will cause the Canadian dollar to weaken against the US greenback, meaning Canadians will need to shell out more, not just for US-produced goods, but for spending on a global scale.

The deviating paths between the Bank of Canada and US Federal Reserve will also cause inflation to rise; the latter, which is the American counterpart to our central bank, has been signalling it no longer needs to cut its own benchmark rate by as much as previously expected, due to resilient US economic growth and jobs market. Meanwhile, sluggish GDP prompted the BoC to slash rates aggressively in the second half of 2024, most recently lowering its rate by 0.25% on January 29th.

The growing spreads between the two central banks’ target interest rates further weakens the loonie, and contributes to inflation growth.

As BMO’s Porter writes, “With the Fed forecast to continue its current pause until June and then resume a quarterly 25-bp rate cut clip, this means Canada-U.S. overnight rate spreads are going to push past -225 bps, testing the all-time extreme of -250 bps during the spring of 1997. With medium- and long-term Canada-U.S. bond yield spreads recently smashing through record negative levels, the market has been sensing extreme overnight spreads too.” 

He adds, “This will no doubt add to the Canadian dollar’s woes along with appreciation in the greenback as America’s tariffs go global. We see the loonie averaging around C$1.49 by this autumn and can’t rule out a run at the C$1.50 level, with the net risk this could occur quicker.”

According to an analysis released with last week’s rate decision from the Bank of Canada, imports from the US, or materials used to make final goods, make up about 13% of Canada’s Consumer Price Index basket. The BoC writes that the tariffs will cause, at minimum, a “one-time, permanent increase in price levels,” and that next steps will depend on “how household and business expectations for inflation respond to tariff-related price level increases.”

How will tariffs impact the housing market?

In a non-tariff scenario, all signs had pointed to a brisk spring season for Canadian real estate; lower mortgage rates, combined with pent-up demand had even prompted the Canadian Real Estate Association to revise their forecast for the year, calling for sales to increase 8.6% in 2025, compared to 6.6%. The national average home price was set to increase by 4.7%, to $722,221. 

But of course, it’s impossible to predict how home buyers will react to the effects of tariffs, and to what extent their purchasing power would be impacted. If households are rocked by recessionary factors such as job loss, even rock-bottom interest rates will do little to support demand. However, if the federal government provides significant fiscal support to protect livelihoods, and the benchmark cost of borrowing falls below 2%, there’s a possibility it  could lead to an ultra-hot housing market – that’s a scenario that played out during the pandemic, when borrowers were driven by the psychological urgency of the lower rate environment.

While far from an apples to apples comparison, similar factors were at play during the first year of the pandemic that we could see again in response to tariffs. The federal government was providing extensive fiscal support to Canadians, totalling over $212 billion for individuals and businesses in the form of special payments, tax deferrals, and the Canada Emergency Response Benefit (CERB).

At the time, the Bank of Canada had reduced its benchmark rate to a historic 0.25%, as part of emergency pandemic measures. It didn’t take long for that to juice the market; by May of 2020, national home sales had increased by 56.9% month over month - by year end, home prices had surged by 17%. Real estate demand and price growth continued steadily, all the way until February 2022, when the national average home price hit its all-time high of $816,720.

We can’t guess for certain if the same phenomenon would occur today – but there’s plenty of precedent for how the combination of low rates and fiscal support can fuel home buyer scarcity psychology. 

Also read:

• How US tariffs on Canada could impact you — and what you can do 
• Bank of Canada cuts target interest rate by 0.25% in January 2025 announcement
• Inflation and the Consumer Price Index in Canada
• Canada housing affordability and market trends