Canada Interest Rate Forecast 2023-2024
Perch's expert mortgage team provides their insight on incoming Bank of Canada (BoC) interest change announcements.
Last updated: January 25, 2023
Perch's expert mortgage team provides their insight on incoming Bank of Canada (BoC) interest change announcements.
Last updated: January 25, 2023
Past 2022 interest rate change announcements:
Bank of Canada interest rate announcements scheduled for 2023 (source):
Central Bank of Canada Overnight Interest Rate: 4.50% (source: BoC)
Canada overnight rate from 2001 (with January 25 2023 BoC announcement)
The current market overnight interest rate forecast for the next 12 months is:
|Variable Rate Interest Forecast 2022 to 2027 (as of Dec 2022)|
|BoC Date||5-year variable rates|
The key interest rate is the minimum interest rate that the Bank of Canada charges on one day loans to financial institutions.
When it comes to predicting what will happen with mortgage rates, it’s a fine balance between art and science. No one can claim with 100% certainty what the Bank of Canada will announce at the next rate announcement. Despite that fact, many of Canada’s biggest banks have experienced economists on their roster in an attempt to make their best, educated guess at where interest rates will go next.
The top banks expect that the overnight rate has peaked at 4.50%, and believe this is likely the final rate hike from the Bank of Canada. With inflation continuing to decelerate, a lot of the recent rate hikes have yet to filter their way fully into the market. We should see these all play out in 2023, as inflation trends back towards the target of 2%. Inflation is just one of the many factors the Bank of Canada focuses on, and we believe the potential further impact to housing and employment will motivate them to err on the side of caution as it relates to overdoing rate hikes.
Toronto Dominion Bank (TD) director of economics, James Orlando, predicts that the peak overnight rate will be reduced back to neutral levels by the end of 2023 with the rate reaching 2% by 2025. Bank of Montreal (BMO)’s chief economist Douglas Porter predicts that rates will hold at 4.5 % through the rest of 2023. BMO’s forecasts show inflation will remain stubbornly high, especially through the first half of the year. (Source: CBC)
Scotiabank economists believe the Bank of Canada is signalling a pause as it waits to assess the impact of its policy actions on inflation and growth and continue to expect that the BoC’s next move will be a cut late in 2023 given the expected slowing in both inflation and growth.
Commentary from Alex Leduc, Principal Mortgage Broker and CEO of Perch:
BCREA Economics expect that the average Canadian variable mortgage rate will rise to 6.35%. They predict that the Bank of Canada will begin lowering its policy rate next year, which will be passed through to variable rates by the end of 2023. They believe that five-year fixed rates have peaked at their current average of 5.5%. Assuming the recent decline in Canadian bond yields is sustained or fall further, fixed mortgage rates should begin falling in early 2023, ending the year around 5%. BCREA expects that the Bank may reverse course in the second half of 2023 as the Bank responds to a significant slowdown in the Canadian economy or even a brief recession. We could see a significant downward trajectory for inflation in 2023 due to weakening economic growth, falling gasoline and other commodity prices, and fading effects from pandemic driven supply chain problems, which would provide the Bank with the necessary support to begin lowering its policy rate.
As announced by Statistics Canada on January 17, 2023, the Consumer Price Index (CPI) rose 6.3% year over year in December, following a 6.8% increase in November.
With inflation coming in well under market expectations, this signals that the Bank of Canada’s goal of cutting inflation to its 2% target is working faster than expected. This should temper the Bank of Canada’s desire to hike rates further as they evaluate if the trend continues. The Bank of Canada has shown its commitment to getting inflation on track, but they’ll be cautious not to overdo it.
The policy interest rate is the primary tool that the Bank of Canada uses to control inflation. This is the starting point for setting many interest rates in the economy. The Bank of Canada sets the policy rate to influence different aspects of the Canadian economy which include the exchange rate, consumer prices, bank interest rates and more.
The overnight rate is also known as the key interest rate. It is the interest rate at which Canada’s banks borrow and lend funds on a one day basis to each other. Banks make deals with each other daily to balance their holdings but this isn’t done for free. Banks charge each other interest on the money they borrow which is known as the overnight rate, representing the cost of borrowing money “overnight”. Canada’s major banks are a part of the Large Value Transfer System (LVTS) which is an electronic system where major banks can conduct large transactions with each other.
The overnight rate as well as the prime rate affect more than just mortgages. The rate represents the bank’s cost of borrowing, so the prime rate can affect all kinds of lending such as credit cards, personal lines of credit, home equity lines and more.
The Canadian prime rate increased by 25 basis points to 6.70% effective January 25, 2023. This is simply the average of the major banks’ prime rate.
In Canada, there are two main types of mortgages, fixed rate and variable rate. With a fixed mortgage you will pay the same rate over the entire course of your mortgage term and it will not be affected by the market. So if the prime rate goes up, your fixed rate will stay the same. A fixed rate mortgage is a good option if you like to know exactly how much your mortgage payments will be until you need to renew. A fixed rate is also good in a rising rate environment since you lock in your rate regardless of what happens in the market.
Variable mortgage rates usually don’t have a set rate, but rather a spread to the prime rate (ex: Prime – 1.00%). When the prime rate in Canada goes up, so will your mortgage rate by the same amount and vice versa. Most lenders will let you convert your variable rate mortgage to a fixed rate mortgage at any time, you will have to pay the fixed rate once you decide to switch.
It’s worth noting that banks offer a variable rate or adjustable rate mortgage and you should be aware of the differences. When prime rates move, a variable rate mortgage payment will stay the same (subject to trigger rates), but your amortization will adjust to shift more/less or your mortgage payment towards paying interest. With an adjustable rate mortgage, your amortization will remain the same and your mortgage payment will change as prime rates move.
The prime rate is not the same as your mortgage rate. A prime rate is the base cost of borrowing from which lenders start to determine interest rates on mortgages, personal loans, credit loans or other financial products. In general, the prime rate mostly affects variable rate mortgages. Your mortgage rate is the interest rate you are expected to pay on any borrowed money.
When the Bank of Canada raises the overnight rate, it becomes more expensive for banks to borrow money. This will result in banks raising their prime rates to cover the added costs. If the Bank of Canada lowers the overnight rate, banks usually will lower their prime rates.
To better determine the mortgage rate forecast, it’s important to take into account historical trends. During the great recession in 2008, the economy was able to get back on track after requiring bailouts and stimulus to keep running. There was very low GDP growth for over 10 years after the 2008 recession, which resulted in low interest rates. From 2020 – 2023 there was a similar economic bailout due to COVID. However, this time the stimulus was far greater, with over 40% of dollars ever created between 2020 – 2022. As a result of the shutdown of the economy and supply chains, difficulty restarting these supply chains as well as the war in Ukraine, inflation is significantly more as the economy stabilizes.
Historical trends show that significant new government debt combined with already massive debt can lead to dependence on even more cheap debt to stimulate the economy. This can lead to long term economic stagnation and an amplified effect of increased rates. There is five times more debt in the economy today, adjusted to inflation than in the 80’s and 90’s, so a 0.25% rate increase can make a much more significant impact compared to when debt levels were a fraction of what our levels are currently. When rates increased from 10% to 20% in the 1980s, this was a 2x rate increase. However, when rates increased from 0.25% to 4.50% in 2022-2023, this was actually a 16x rate increase which will impact the economy significantly more.
The rapid rise in interest rates due to record high inflation is expected to subside in 2023 and rates will come down as a result.
On Wednesday, January 25th, 2023, The Bank of Canada announced a 25 basis point increase, which is its 8th consecutive rate hike, pushing the key interest rate from 4.25% to 4.50%. This increase was widely predicted by economists ahead of the official announcement. At 4.50%, this is the highest the interest rate has been since 2008. Fixed mortgage rates will stagnate and variable rates will increase slightly in January 2023.
Currently the market is predicting that rates will start to decrease in the second half of 2023. This is reflected through higher rates for 1 or 2 year terms (vs 5 year terms) with every bank currently, which is also supported by a negative yield curve for bond yields. Historically, when we are in a recession, the first rate drop occurs within 18-24 months of the initial increase. As the first increase started in March, this would put us on a projection to see the potential first rate rate drop in the Fall of 2023. This rate drop wouldn’t be significant (predicted 25 bps) but it will provide welcome relief to homeowners who are stretched to their limit currently. Psychologically, people will then also be influenced by future monetary policy expectations and this should motivate a lot of people on the sidelines to get back into the real estate market.
By the end of 2023, Ali Hussain, Head of Mortgage Advisory at Perch, forecasts fixed rates reaching low fours on five-year terms. He also anticipates the Bank of Canada to lower the overnight lending rate in the second half of 2023, causing lower variable rates.
The Bank of Canada is expected to cut their overnight rate by 0.50% in the later half of 2023, which means variable rates should start to come down slightly in 2023.
Based on our latest insights, here is Perch’s forecast for 5-year variable rate mortgages in Canada from 2023 to 2028, in comparison to the last 2 quarters, on how that will affect variable mortgage rates. Back in September, the short-term variable rate (2024-2025) was expected to hover around 4%, whereas now it’s expected to be closer to 3.50%. This is much lower than originally forecasted, which should be welcome news for many homeowners.
5-year bond yields are expected to also come down around 0.75%, which should be reflected in 5-year fixed rates as well.
The strategies for a variable rate are more or less the same as a fixed rate, with the only exception being that your payment may change at any time if the bank’s prime rate changes (up or down). For this reason, future salary gains and refinancing are less likely to be relevant if your payments change materially in the near term.
One thing to consider is that with a variable rate mortgage, most lenders allow you to lock in a fixed rate with no penalty at any time in your mortgage term. This option at least enables you to lock in a payment if rates go in a direction that was largely unforeseen.
Unfortunately, nobody has a crystal ball to predict with certainty where fixed mortgage rates will be in the future. It’s not necessarily interest rate risk that is the main problem, the key risk is that the rate on renewal is incompatible with your budget. There are a few ways you can protect against this:
Be realistic about salary gains
Most people have a 5-year term on their mortgage. 5 years from now (especially if you’re earlier in your career), it’s very likely that your income will be higher and that a higher mortgage rate would take up as much of your budget as it does now. Budget for what your future salary could be to understand how much interest rates would have to rise for it to be a problem.
Picking the right mortgage lender
Some lenders offer re-advanceable home equity lines of credit which you can use to reduce your mortgage payment. If you are wondering the difference between a bank and a mortgage broker, this article is for you.
Refinancing instead of renewing
When you renew your mortgage, typically that means you are simply locking in a new rate. However, you could alternatively refinance the mortgage (meaning you start a brand new amortization) to reduce your monthly payment even if your mortgage rate goes up. For example, assuming a $500,000 mortgage at a rate of 5%, under a 20 and 30 year amortization your monthly payment would be $3,286 and $2,668 respectively. Here are the pros and cons of refinancing your mortgage.
Consider rental income
If any part of your home could be rented out, that additional income could be used to offset a higher mortgage payment.
Canada used to offer a 40 year amortization, however this changed in 2008 when the federal government decided to tighten lending regulations. Today, the longest amortization you can get in Canada is 35 years.
If you’re buying a property and your down payment is less than 20% of the price of your home, the longest amortization you're allowed is 25 years.
According to the Bank of Canada, as of Q4 2021, about 35% of Canada owns real estate with a mortgage. Of that group, the majority have a fixed mortgage. With variable rate mortgage holders, a minority have variable payments, roughly 2% of all Canadians. So no, adjustable rate mortgages are not that common.
source: Bank of Canada (BoC)
A bond creates value over its lifetime until it matures, and the yield is a measure of how much value the bond creates. Government bonds help the government pay for its operations and pay off its debt. It is also known as a ‘security’ which means the buyer is lending the government money, and is guaranteed they will be paid back the face value of the bond when it matures. In Canada, bonds are considered to be very secure investments. The buyer also receives interest payments on their loans to the government for the duration of the bond’s term.
Yield is a bond’s return and is calculated as a coupon yield or a yield to maturity (YTM).
A coupon yield is a set percentage of the bond’s face value paid at regular intervals such as 15% a year. If you bought a bond for $1,000 with a 15% coupon, you would be paid $150 every year until that bond matures. A bond’s YTM is the sum of all the interest payments you would receive throughout the term of the bond. This also includes any gains or losses depending on if you bought the bond at a discount or a premium.
If you decide to sell a bond, the price you paid for it initially might have changed. If you bought a bond at face value for $1,000 and is worth $500 when you sell, it would be considered selling at a discount. If the bond has increased to $1,500, this would be considered selling at a premium. Regardless of the price of the bond when selling, the coupon percentage remains the same. The seller would still receive $150 a year based on the original value of the bond.
The Government of Canada 5 year Bond Yield factors in all known economic data very frequently. When the market and bond traders believe that the Central Bank of Canada will increase rates, the Bond Yield increases and vice versa. In other words, the Bond yield is priced in anticipation of where the Central Bank of Canada rates will move. The Central Bank of Canada makes its rate decisions, based on the status of the economy. Currently for the Canada 5-Year Bond Yield, Canadian bonds are priced in anticipation of a further 0.75% increase in Central Bank of Canada rates in 2022 and early 2023.
Banks will originate mortgages and then pool a bunch of them into what is called a mortgage backed security (MBS) to be sold off to investors (someone like a pension fund for example) who collect a yield on the MBS. The pension fund could invest in other fixed income investments, so mortgage rates rise as a result to entice investors to keep buying the MBS. lBond yields and mortgage rates move in the same direction.
5-year bond yields dipped to 2.9% in mid December, pushing lenders to decrease long term fixed rates well below 5% for the first time in nearly 6 months. While bond yields have trended back above 3% at the end of year, we see no further incoming increases to fixed rates in the near term as lenders compete during a slower December and January, variable rates could stagnate in 2023 and become a popular option once again as the Bank of Canada rate hike cycle ends.
If you're a borrower, here's a few things you can do:
Since the mortgage backed security (MBS) is a higher risk investment than buying a bond in the Canadian Government, the return on it must be higher. With that being said, lenders also compete with each other for mortgages so each lender determines how low they want their rates to be.
The COVID-19 pandemic had a major impact on the global and Canadian economies. Many employees were laid off and businesses had to close their doors since the global supply chain was put on pause. Now the demand for goods and services is becoming greater than what the economy can produce in Canada and this excess demand is causing inflation. To control inflation, the Bank of Canada raised its policy interest rate 3 consecutive times, resulting in an increase of 125 basis points from March to the end of June 2022.
High interest rates are intended to control how much Canadians are spending. Typically businesses and consumers will cut back on spending when interest rates are rising. When interest rates have fallen significantly, consumers and businesses will increase spending.
High rates and high inflation is a burden to many Canadians. However, higher rates are intended to bring inflation down and can take time to work. Changes to the Bank of Canada’s policy rate affects different households and sectors of the economy differently and at different speeds.
Recessions come with reduced economic activity and higher unemployment rates. When there is less demand, interest rates fall. When rates rise, the cost of borrowing is high and could possibly lead to a shrinking, rather than growing, economy.
A floating interest rate (also referred to as an adjustable or variable rate) will change throughout the life of your mortgage loan and is normally tied to different economic indexes such as the prime rate. Your loan will “float” up or down depending on changes to your reference rate (usually prime rate). For example, if you mortgage had a rate of Prime+1.00%, if prime rate moves your interest rate will follow along. This could have implications on your payments, amortization or both.
CIBC economics say that the Bank of Canada appears to be looking for a weakening in the labour market as evidence that demand is moving back into line with supply. Another small step in that direction in December, and a gradual rise in the jobless rate during 2023, should be the evidence policymakers need to prevent a further interest rate hike in 2023. CIBC analysts predict that the Bank of Canada will increase overnight rates to 4.25% and maintain them at elevated levels through 2023, which will slow demand and allow inflation to end next year near its 2% target. Long-term interest rates in Canada and the U.S. could be at lower levels at the end of 2023 as the market starts to price-in a modest easing in central bank policy rates in 2024 and predicts that inflation will be under control.
RBC economics says that after a 50 basis point hike at the December meeting, they expect the BoC is now free to pause at the current overnight rate of 4.25% as the lagged impact of interest rate increases to-date slow economic activity.
According to Tom Percelli, chief U.S. economist at RBC Capital Markets, the U.S. will expect several more interest rate hikes in 2023 to bring back stable prices and return inflation to 2% over time. 17 Federal Reserve officials on the monetary policy committee have estimated that the Fed’s target interest rates would have to raise about 5% in 2023 and could possibly take prime rates well above 7%. It is expected that the Bank of Canada will have similar levels as the Fed’s and also means Canadian borrowers might be affected when their banks need to back up the risks of long-term lending in the U.S. bond market. (source CBC)
TD Economics predicts that the peak overnight rate will be 4.5% in the first quarter of 2023 and will be reduced back to neutral levels by the end of 2023 with the rate reaching 2% by 2025. They also predict that short and long term bond yields will decline over 2023 as the weak economic backdrop will result in expectation for policy rate cuts.
Scotiabank expects the Bank of Canada to reduce its overnight rate by 0.25% to 4% by the end 2023. They predict that the Canadian central bank will lower it by 1% to 3% by the end of 2024. They continue to expect that the BoC’s next move will be a cut late in 2023 given the expected slowing in both inflation and growth.
BMO’s chief economist, Douglas Porter, predicts that inflation will remain high in 2023, especially through the first half of the year. He predicts that the Bank of Canada will have one more rate hike in January and will hold rates at 4.5 % through the rest of 2023. (source CBC)
Based on our analysis we believe that the rate hikes are almost over. Currently, fixed rates are approximately 50 basis points higher than your current rate so if you want to have a fixed payment and you are okay locking in a higher interest rate, please speak to one of our advisors to see what is best for you.
You can also see if the option to extend your amortization (which can lower your payments) is an option with your lender. If you have purchased at least 2 years ago this may be an option to reduce your mortgage costs.
A longer amortization means that it will take you longer to pay off your mortgage in full and lowers your mortgage payments accordingly. There is no limit to how many times you can extend your amortization, so you could opt to extend your amortization at every renewal if the payments were too high for you to service.
There are two key factors at play here: Rate expectations and mortgage operations.
According to current projections, rates will start to drop by next year, with meaningful drops to occur over the following next year. For that reason, the bond market (the market that influences fixed rates) has priced those shorter terms higher with the expectation of falling rates a few years from now.
Lenders also typically pool large quantities of mortgages together and sell them off through a process called securitization. These pools are typically predominantly filled with 5-year mortgages, which makes the demand for those terms higher than any other and they’re priced lower as a reason since banks can fund them cheaper than other terms.
If you have a fixed rate mortgage, you will not be affected by interest rate changes during your mortgage term. However, if you have a variable rate mortgage, interest rate changes will have a direct impact and you could be at risk of reaching your trigger rate.
Each mortgage payment is made up of the principal and interest. The principal is the portion of your payment that goes to your balance owing and interest is the bank’s fee for letting you borrow their money. A variable rate mortgage has an interest rate that is determined by your lender’s prime rate. Variable mortgages have fixed payments, which means that with rising interest rates a larger portion of your payment will be put towards interest and less towards your principal.
A trigger rate is the rate at which a mortgage enters negative amortization, which means your payments don't cover the interest and your mortgage balance is increasing as a result. This means your entire mortgage payment is going to interest and none of it is going towards your principal. When you reach your trigger rate, you have essentially stopped paying off your mortgage and have started borrowing more. Any amount still owing is called deferred interest and is added to your balance so it can be paid later on.
Your trigger rate will be outlined in your mortgage commitment letter, but this is an easy way to estimate your trigger rate:
Trigger rate estimate = (mortgage payment x payments per year / mortgage owing)
The higher your amortization, the difference between trigger rate and the original rate is less. The reason for this is that when you have a high amortization, a large part of your mortgage payment is already interest and not principal, meaning there’s less room for higher interest payments as a percentage of your payment. Most people get a 25 year amortization, so the trigger rate would be met after the Prime rate increases around 2%.
Your lender will most likely reach out to you to let you know that your payments are no longer enough to pay down your mortgage. They will explain your options and can advise you on how to proceed. You can either bring your amortization back in line by increasing your mortgage payments, or the lender may allow for negative amortization and your mortgage balance will grow. Note that these solutions will only apply during your mortgage term, when your mortgage matures everything will be recalculated at the target amortization.
The Bank of Canada's latest report showed that 23% of mortgages have fixed payment variable rate mortgages (vs adjustable rates, which have variable payments), or true variable rates. They estimate that 50% of those have hit their trigger rate, which is about 12% of all mortgages.
Major lenders (TD and CIBC) have already started allowing borrowers to enter negative amortization, or to shift the extra interest paid into principal. This reduces the exposed percentage even further.
You’ve likely seen a lot of news headlines about trigger rates and increasing mortgage payments. Perhaps you’ve had a family member mention hitting the trigger rate on their own mortgage, and they're worried about the impact it has on their budget.
If you have a fixed mortgage, the trigger rate doesn’t apply to you since your mortgage payments and interest rate are locked in for the duration of your term.
If you have a variable mortgage rate, but your monthly payments automatically go up with every rate hike, the trigger rate doesn’t apply to you. This type of mortgage is called an adjustable rate mortgage.
If you have a variable mortgage rate, and your monthly payment amount remains the same even when the interest rate changes, then the trigger rate does apply to you. When you hit the trigger rate, you can expect to hear from your mortgage lender or mortgage advisor about increasing your mortgage payment. When the rate hikes have increased to the point where you’ve hit the trigger rate, it means your current monthly payment amount isn’t enough to cover the interest and pay down your mortgage.
Biggest increases in mortgage payments will be at renewal with new market rates. Your payment will go up as your amortization goes back to normal. For example, if you had a 25 year amortization and a 5 year term, at renewal your amortization would be 20 years regardless of how high your current amortization is due to rising rates.
Luckily, bond yields have started to come down and it is expected that banks will lower their mortgage rates. This means the expected increase at renewal should also start to narrow, reducing the pain at renewal.
Many Canadians opted for a variable rate in 2022 mainly because it made a large difference in qualifying power. In early 2022, rates were also extremely low (in Q1, we saw variable rates as low as 0.95%) and many weren't informed on the forecasted rate increases to budget appropriately.