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Canada Interest Rate Forecast 2022

Perch's expert mortgage team provides their insight on incoming Bank of Canada (BoC) interest change announcements.

Last updated: December 1, 2022

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Monthly Interest Rate Forecasts

Past 2022 interest rate change announcements:

There are one more Bank of Canada interest rate announcements scheduled for 2022:

  • Wednesday, December 7, 2022 (source)

See 2023 Bank of Canada interest rate announcement schedule

Central Bank of Canada Overnight Interest Rate: 3.75% (source: BoC)


Canada overnight rate from 2003 (with October 26 2022 BoC announcement)

When is the next Bank of Canada rate increase and what can I expect?

The current market overnight interest rate forecast for the next 12 months is:

  • A 0.50% increase December 7th, 2022
  • No change January 25th, 2023
  • A 0.25% increase March 8, 2023
  • No change April 12, 2023
  • A 0.25% increase June 7, 2023
  • No change July 12, 2023
  • No change September 6, 2023
  • No change October 25, 2023

What is the key interest rate in Canada?

The key interest rate is the minimum interest rate that the Bank of Canada charges on one day loans to financial institutions.

What is policy interest rate?

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.

What does the target overnight rate mean in Canada?

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.

Does the overnight rate only affect mortgages?

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.

What is the Canadian prime rate?

The Canadian prime rate increased by 50 basis points to 5.95% effective October 26, 2022. This is simply the average of the major banks’ prime rate.

How does the prime rate affect mortgage rates in Canada?

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.

Is prime rate the same as mortgage rate?

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.

How does the overnight rate affect the prime rate?

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.

What is the mortgage rate forecast for 2023?

The primary reason for the rapid rise in interest rates in 2022 was due to record high inflation. This is expected to subside in 2023 and rates will come down as a result.

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.

Fixed Rates

5-year bond yields are expected to also come down around 0.75%, which should be reflected in 5-year fixed rates as well.

Is there a variable mortgage rate strategy to reduce interest rate risk?

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.

Is there a fixed mortgage rate strategy to reduce interest rate risk?

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.

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.

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.

What is a bond yield?

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.

What determines bond yield prices?

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.

How are bond yields related to fixed mortgage rates?

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.

Are fixed mortgage rates set higher than bond yields?

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.

What impact did COVID-19 have on the Canada interest rate?

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.

What impact does consumer spending have on the Canada interest rate?

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.

How is the Canadian economy affected by rates?

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.

How do rates affect a recession?

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.

What are floating interest rates?

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.

What are the interest rate predictions from the banks?

 

CIBC

CIBC chief economists Benjamin Tal and Karyne Charbonneau believe that the overnight target rate will remain at 3.25% for the duration of 2023 and do not see any further rate hikes in 2023. However, they do not expect the Bank of Canada to begin easing rates any sooner than 2024.

RBC

RBC Economics predicts that the Bank of Canada will increase the overnight rate in the fourth quarter by 0.75% to 4% and maintain the level until the end of 2023.

TD Canada

TD Economics predicts that the Bank of Canada will increase the overnight rate by 0.75%in the fourth quarter to 4% and cut it back down by 0.50% to 3.50% by the end of 2023. They the predict the Canadian central bank to lower the policy rate to 2% in 2024 where it will remain for the next few years.

Scotiabank

Scotiabank expects the Bank of Canada to raise its overnight rate by 1% to 4.25% in the fourth quarter of 2022 and reduce it 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.

What options do I have if I am on a variable mortgage?

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. 

What does extending my amortization mean for my future renewals?

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.

Why are 1 and 2 year terms higher than 3 and 5 year terms?

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.

How do interest rate changes affect mortgage trigger rates?

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.

Is there a trigger rate calculation?

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)

How does my amortization affect my trigger rate?

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%.

What happens if I reach my trigger rate?

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.

How have interest rate changes affected mortgage trigger rates in 2022?

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.

How will mortgage payments be affected for those who need to renew in the future?

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.

Why were variable rate mortgages popular in 2022?

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.

The Bank of Canada has also shared its 2023 schedule of upcoming interest rate announcements. The confirmed dates are as follows (source):

  • Wednesday, January 25, 2023
  • Wednesday, March 8, 2023
  • Wednesday, April 12, 2023
  • Wednesday, June 7, 2023
  • Wednesday, July 12, 2023
  • Wednesday, September 6, 2023
  • Wednesday, October 25, 2023
  • Wednesday, December 6, 2023

 

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