A sneak peek behind the Bank of Canada’s latest rate hike
Your mortgage news update for the week of June 23, 2023
Memo 1: New insights behind the Bank of Canada’s latest rate hike
The Bank of Canada released its latest Summary of Deliberations on Wednesday, offering a peek into the thought process behind the central bank’s quarter-point rate hike on June 7.
The memo details the discussions between the Bank’s Governing Council of monetary policymakers as they mulled over the current economic climate as well as progress in the fight against inflation – and it’s clear they weren’t pleased with the state of either.
Their main concerns are stubbornly high core inflation, and the fear it may be sticky enough to hover above the Bank’s 2% target for the long term. The resilience of the economy – namely strong employment and consumer spending – was also taken as proof that the Bank’s attempts to cool CPI growth through hikes haven’t been sufficient. Most recently, the CPI reading in April came in higher than expected, rising 4.4% year over year, scuttling hopes it was starting to materially cool.
“Despite higher interest rates, consumer demand was proving more robust than Governing Council had expected,” reads the summary. “This was evident in the national accounts data for the first quarter—which showed that consumption growth was very strong—and in recent increases in housing resales and prices.”
GDP growth also continues to outstrip the Bank’s expectations, rising 3.1% in the first quarter of 2023, rather than the forecasted 2.3%. This has led the central bank to believe that “the full effects of past monetary policy tightening have yet to be felt,” with pent-up demand for goods and services – which had been stymied by pandemic lockdowns and ensuing supply chain issues – effectively fuelling spending activity.
A hotter-than-expected spring recovery in the housing market also appears to have surprised the Bank; national home sales rose by 1.4% year over year in May – the first annual increase in 24 months – and up 5.1% from April. The average home price also marked its first annual growth (+3.2%) in 12 months, rising to $729,044.
In all, the economic data was too strong to ignore – while the notes indicate the Council considered holding off on their hike until July, they decided to act sooner, with the “need to be forward-looking and not wait too long to ensure that monetary policy was restrictive enough.”
The Bank has increased its trend-setting Overnight Lending Rate a historic nine times between March 2022 and June 2023, bringing it up by 4.5% from its pandemic-era low of 0.25%. As a result, it sits at 4.75% today, leading to a prime rate of 6.95%, and materially higher variable mortgage rates than what were available just one year ago.
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Memo 2: Strong retail sales support July hike
Inflation may be biting into spending power, but that’s not stopping Canadian shoppers from hitting the mall – the latest retail sales numbers are surprisingly strong, according to the latest data released by Statistics Canada.
The report shows retail sales rose 0.5% annually, following a 1.1% increase in April to $65.9 billion. That’s blown the 0.2% figure estimated by StatCan out of the water, and has effectively wiped out the declines that occurred in February and March.
Sales rose in eight of the nine categories tracked by the data agency, and across eight provinces. “Core” retail sales were up 1.5% – their fifth consecutive increase – while food and beverage retailers saw sales rise by 1.5%.
Auto sales also increased, with sales and motor vehicle and parts dealers up 0.5%.
“The Canadian consumer continues to prove its resilience, this time with a solid gain in retail sales for April,” writes BMO Economist Shelly Kaushik. “That said, higher prices drove most of the increase as spending volumes rose at a much slower pace. Looking ahead, momentum in consumer spending is expected to slow in the second half of the year, as yet higher interest rates and still-elevated inflation continue to weigh on purchasing power."
Given StatCan expects yet another uptick in May with a 0.5% increase, all eyes will be on the May CPI report for clues as to whether another Bank of Canada hike is indeed in the cards come July.
“Coming off a strong first quarter of consumer spending, a second consecutive monthly move higher is not what the Bank of Canada will be looking for as it hopes to slow domestic demand,” writes Randall Bartlett, Desjardins’ Senior Director of Canadian Economics. “Indeed, we're tracking Q2 real GDP growth of around 2% annualized, roughly double the pace in the Bank's most recent forecast. As such, today’s retail print just works to reinforce our call that another 25 basis point hike in July is likely.”
Memo 3: Banking regulator warns against extending mortgage amortizations
As variable mortgage rates have soared alongside the Bank of Canada’s hiking cycle, more borrowers are finding themselves struggling to keep up with their monthly payments. Those with variable rates on an adjustable payment schedule have already absorbed the increases as their payment is impacted each time the central bank tweaks its rate. Those with variable mortgages on a fixed payment schedule, however, haven’t seen any change to how much they’re shelling out monthly – instead, less of their payment goes to their overall principal mortgage balance.
Increasingly, these borrowers have hit what’s called their “trigger rate” – the point at which their payment no longer goes toward their principal, and covers interest costs only. To mitigate this, lenders have offered flexible solutions, such as extending borrowers’ overall amortization limits.
Doing so immediately provides monthly payment relief, but the trade-off is it takes longer to pay down the mortgage – and the borrower will incur thousands more in interest costs over time. And these amortizations are stretching longer and longer. According to recent regulatory financial disclosures from Canada’s biggest lenders, the number of clients with amortizations over 30 years – or even exceeding 40 years – has skyrocketed. At CIBC, for example, they make up 30% of the books. RBC reported 25%, and 32% at BMO.
Canada’s banking regulator – the Office of the Superintendent of Financial Institutions (OSFI) – is less than pleased with this development. As reported by Reuters, the regulator wants lenders to address the resulting risks from these extended mortgages at their “earliest opportunity”.
"OSFI expects a more prudent and active account management approach, including resolving negative amortization at the earliest opportunity as well as recognizing the higher risk of these loans in loss provisioning," the regulator stated to Reuters.
"Our ongoing conversations with financial institutions have highlighted the importance of being proactive in managing all types of mortgage accounts, and to act before levels of borrower stress become unmanageable."
This echoes a previous statement provided to Ratehub.ca by Tolga Yalkin, Assistant Superintendent, Policy, Innovation and Stakeholder Affairs at OSFI, who doubled down on the risks concern posed by these lengthier loans.
“While increasing amortization is one way to cope with higher interest rate hikes in the short term, it’s not without risk. Extended amortizations will lead to a greater persistence of outstanding balances, and greater risk of loss to lenders," he said.
"Our conversations with financial institutions have emphasized the need to be proactive in managing all types of mortgage accounts, and to act before levels of borrower stress become unmanageable. Ultimately, these are decisions that will be made at the lender level and we appreciate that lenders are working with borrowers to manage cost increases while also ensuring the actions taken remain within the institutions’ risk appetite, including holding appropriate reserve levels."
The regulator’s stance also appears to dash any industry hopes that longer amortizations could be introduced in the next batch of mortgage regulation changes, given today’s overall tougher interest rate environment; currently, those taking out new, low-ratio mortgages are capped at an amortization of 30 years, with high-ratio insured borrowers at 25 years.