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Bank of Canada Keeps Rates Unchaged in a Surprise Move

In a twist that defied expectations, the Bank of Canada (BoC) opted for continuity, leaving its key policy rate at 5.00%, a 22-year high. This decision was precisely what the bond market had anticipated.

Canada's overnight rate v.s. 5-year bond yield
Canada's overnight rate v.s. 5-year bond yield (Source: Refinitiv)

Today's decision to pause rate hikes offered a moment of relief for average variable-rate borrowers, potentially saving them up to $70 on their monthly payments. (Based on the average Canadian mortgage amount of $351,692 according to TransUnion.)


Leading up to this rather anticlimactic decision, several provincial premiers had vocally opposed the BoC's rate hikes, urging it to halt. Some dismissed this as political theatrics, but Scotia's VP & Head of Capital Markets Economics, Derek Holt, suggested that it signifies the effectiveness of the tightening policy. He commented, "They're now stomping their feet in much the same way a child would when screen time is cut off."


However, the real driver behind BoC's pause 2.0 wasn't political pressure; it was the data.


Unemployment has been gradually on the rise, with another report due in two days. Additionally, Q2 GDP showed a disappointing contraction of 0.2%. As GDP is a lagging indicator, it raises concerns about another negative reading in Q3, well below the BoC's predictions.


This is significant for mortgage holders because it implies that rates may not return to the so-called neutral range (around 2.50%, as per BoC estimates) for several quarters, possibly even a couple of years, unless a severe recession or global crisis occurs. In such a case, it would depend on the government's fiscal response.

 

As of noon ET, Canada's 5-year bond yield has risen by 4 bps to reach 3.99%, following the trend of the U.S. 5-year bond, which is 6 bps higher.

 

Former BoC governor David Dodge remarked that the days of "going back to the 2% interest rate at the Bank of Canada that we enjoyed in the ten years leading up to COVID" are gone. He acknowledges that while the BoC currently deems the effective lowest rate to be 0.25%, it can lower rates in a crisis if economic conditions warrant it. Major rate reductions occurred in 2008 and again in 2020. In short, history has shown that unexpected events can alter the course of interest rates.


Furthermore, oil prices are on the rise, a trend with a well-established link to inflation. This potentially increases the risk of an unexpectedly high August CPI reading, possibly pushing headline inflation "close to 4%," as per BMO Chief Economist Douglas Porter.

Crude Oil
Crude Oil (Source: Refinitiv Eikon)

You can be sure that the Bank of Canada has this chart bookmarked on its Reuters and Bloomberg terminals.


The Bank of Canada's New Focus

The pivotal paragraph in the BoC's recent statement is clear:

​ "Year-over-year and three-month measures of core inflation are now both running at about 3.5%, indicating there has been little recent downward momentum in underlying inflation. The longer high inflation persists, the greater the risk that elevated inflation becomes entrenched, making it more difficult to restore price stability."

The BoC is signaling concerns about inflation psychology, the belief that prices will continue to rise. It is prepared to take action to prevent expectations of higher prices from setting in. The Bank affirmed that it "remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed."

 

We'll receive two more CPI readings before the BoC's next rate meeting on Oct. 25, with reports scheduled for Sept. 19 and Oct. 17.

 

Anticipating What's to Come

Here are the latest implied Bank of Canada Rate Probabilities from Refinitiv:

Implied Rates & Basis Points

These imply that Canadian borrowers may contend with a prime rate near or at 7.20% for several months.


For the time being, today's decision may provide a measure of stability for the real estate market, which has been on edge. Market sentiment might see a modest improvement, though buyers have become more cautious, having learned that a "pause" doesn't necessarily indicate a rate peak.


Furthermore, "active real estate listings are up 16% year-on-year and are not being absorbed as quickly," as per BMO's recent report.


With a looming recession and no dramatic drop in mortgage rates on the horizon, any resumption in housing price growth is expected to be more subdued for the rest of the year.


As you navigate these financial developments, it's essential to tailor your financial plan accordingly. Reach out to us today for a personalized consultation. I'm ready to help you understand the implications and guide you in securing your financial future. Don't wait, take charge of your financial planning now.

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