Today, the Bank of Canada increased its overnight benchmark interest rate 25 basis point to 4.50% from 4.25% in December. This is the eighth time since March 2022 that the Bank has tightened money supply to address inflation.
While the headline increase will certainly make news, it is the Bank’s accompanying commentary on its future moves that will capture the most attention. We summarize the Bank’s observations below, including its forward-looking comments on the potential for future rate increases.
- Inflation has declined from 8.1% in June to 6.3% in December, reflecting lower gasoline prices and, more recently, moderating prices for durable goods
- Despite this progress, Canadians are still “feeling the hardship” of high inflation in their essential household expenses, with persistent price increases for food and shelter
- Short-term inflation expectations remain elevated and while year-over-year measures of core inflation are still around 5%, 3-month measures have come down, suggesting that core inflation has “peaked”
Canadian economic and housing market performance
- The Bank estimates Canada’s economy grew by 3.6% in 2022, slightly stronger than was projected in the Bank’s Monetary Policy Report in October, however it projects that growth is expected to “stall through the middle of 2023,” picking up later in the year
- Canadian GDP growth of about 1% is forecast for 2023 and rising to about 2% in 2024, little changed from the Bank’s October outlook
- The economy remains in “excess demand” and the labour market remains “tight” with unemployment near historic lows and businesses reporting ongoing difficulty finding workers
- However, there is “growing evidence” that restrictive monetary policy is slowing activity especially household spending
- Consumption growth has moderated from the first half of 2022 and “housing market activity has declined substantially”
- As the effects of interest rate increases continue to work through the economy, spending on consumer services and business investment is expected to slow
- Weaker foreign demand will likely weigh on Canadian exports
- This overall slowdown in activity will allow supply to “catch up” with demand
Global economic performance and outlook
- The Bank estimates the global economy grew by about 3.5% in 2022, and will slow to about 2% in 2023 and 2.50% in 2024 — a projection that is slightly higher than the Bank’s forecast in October
- Global economic growth is slowing, although it is proving more resilient than was expected at the time of the Bank’s October Monetary Policy Report
- Global inflation remains high and broad-based although inflation is coming down in many countries, largely reflecting lower energy prices as well as improvements in global supply chains
- In the United States and Europe, economies are slowing but proving more resilient than was expected at the time of the Bank’s October Monetary Policy Report
- China’s abrupt lifting of pandemic restrictions has prompted an upward revision to the Bank’s growth forecast for China and “poses an upside risk to commodity prices”
- Russia’s war on Ukraine remains a significant source of uncertainty
- Financial conditions remain restrictive but have eased since October, and the Canadian dollar has been relatively stable against the US dollar
Taking all of these factors into account, the Bank decided today’s policy rate increase was necessary and justified.
However, the Bank also offered this important piece of news: “If economic developments evolve broadly in line with (its) outlook, Governing Council expects to hold the policy rate at its current level while it assesses the impact of the cumulative interest rate increases.”
That sounds positive, but as is customary, the Bank also noted that it is prepared to increase the policy rate further if needed to return inflation to its 2% target. It also added the usual language that it “remains resolute in its commitment to restoring price stability for Canadians.”
Although the Bank did not say it, the bottom line is Canadians will have to wait and see what comes next.
Next touch point
March 8, 2023 is the Bank’s next scheduled policy interest rate announcement and we will be on hand to provide an executive summary the same day.
This is from the Desk of Dr. Cooper, our Economist, and this data is 1 of the reason we are at Dominion Lending – to get this data.
Below is the details of the government expanding the STRESS TEST, or other mechanisms, to make it harder to buy a home.
OSFI Is Concerned About Federally Insured Lender Exposure to Mortgage Risk.
Late last week, the Office of the Superintendent for Financial Institutions (OSFI) announced it was concerned about the risks associated with the large and rising number of highly indebted borrowers, especially those with floating-rate mortgages, which stands at a record proportion of outstanding mortgage loans.
With the economy in danger of entering a recession and the Bank of Canada warning of potentially more rate hikes to counter persistent inflation, the housing market may face continued pressure in the coming months.
A record number of buyers used floating-rate debt for purchases during Canada’s pandemic-era real estate boom. Those borrowers may come under increasing strain if mortgage costs remain high. Job losses from an economic slowdown also would make it harder for people to keep up with loan payments and stay in their homes.
Superintendent of Financial Institutions Peter Routledge said a review of the country’s mortgage-underwriting rules that starts later this week would look beyond its current main measure — a stress test requiring borrowers to qualify for higher interest rates than what their banks are offering.
“The question in our minds is, is it sufficient?” Routledge said of the current stress test. “So we will look at a broader range of debt-serviceability tools, including debt-to-income constraints, debt-service constraints, as well as the current interest-rate stress test tool.”
The proposed rules—subject to public consultation—include loan-to-income and debt-to-income restrictions, new interest rate affordability stress tests and debt-service coverage restrictions.
Highly Indebted Borrowers
OSFI is particularly concerned about the rise in mortgage originations to households with a loan-to-income ratio of 450% or more, which the Bank of Canada has long asserted is the sector most at risk of delinquency and default. This risk has repeatedly been highlighted in the Bank’s financial risk analysis–the Governing Council’s Financial System Review. The latest report says, “Those with high debt are more vulnerable to a decline in income and will face more financial strain when they renew their mortgages at higher rates.”
This vulnerability relates to households’ ability to continue servicing their debt if incomes decline or interest rates rise without significantly reducing their consumption. The Bank staff estimate that the most highly indebted households have generally seen the smallest increases in liquid assets. At the same time, alongside higher house prices, many households have taken out sizable mortgages to purchase a house, adding to the already large share of highly indebted households.
The chart below shows that the average share of high loan-to-income borrowers before the pandemic was 23.8%. The average since the pandemic onset has risen to 33.7%.
Proposals for Comment
To date, mortgage delinquency rates at federally regulated financial institutions (FRFIs) are at a record low. The large FRFIs have worked closely with borrowers who have reached their trigger points. TD, CIBC, and BMO have allowed some negative amortizations until renewal. As a result, the proportion of their mortgages having remaining amortizations has risen sharply (see second chart below). Questions remain regarding how they will deal with this at renewal time. Will the new mortgage be amortized at 25 years at renewal, raising the monthly payments dramatically and increasing the risk of delinquency or default, especially among highly indebted households?
Earlier last week, CEOs of the Big 5 banks weighed in on vulnerable mortgage clients. None were quite as forthcoming as Scotiabank’s new President and CEO, Scott Thomson, who said the bank has about 20,000 borrowers that it considers “vulnerable.” These are borrowers with a high loan-to-value (LTV) mortgage, a low credit score, lower deposits in their checking accounts and those with home valuations that are susceptible to market conditions.
“So, as you think about the tail risk, we have about 20,000 vulnerable customers, which would be 2.5% [of the total portfolio],” he said Monday during the RBC Capital Markets Canadian Bank CEO Conference.
However, he added this represents a “manageable-type situation for us on mortgages.” Scotiabank’s floating-rate mortgages are not fixed payment. They adjust monthly payments every time the central bank changes the overnight rate.
According to Steve Huebl at Canadian Mortgage Trends, RBC President and CEO Dave McKay said that his bank is “keeping a watchful eye on its mortgage clients, turning to AI and various types of modelling to forecast clients’ cash flow.”
“We look at incomes, we look at the stress of inflation on expenses in a household, and we monitor cash flow to interest payments, as you would in any corporation,” McKay said during the conference. “We do that [for] every single consumer in our portfolio because over 80% of our clients have their core checking and core cash management with us.”
Looking at the bank’s variable-rate mortgage portfolio, which totals between $100 and $120 billion, McKay said the bank has been able to segment that group of clients, keeping tabs on when they reach their trigger rates and when they’ll be coming up for rate resets in the next several years.
Through modelling, the bank can then predict which clients with upcoming renewals “will or will not have a cash flow challenge” should the economy enter a moderate or severe recession, he said. “We have a pretty clear view of that.”
For clients who have difficulties making their payments, mortgage lenders have several options to try and assist borrowers before the situation progresses to the point of them needing to sell their homes.
“You have skip-a-payment deferrals, you have maturity extensions, whatever it happens to be, you have a lot of ways to work with that client,” McKay said.
In terms of clients with cash flow challenges in addition to a collateral problem, where the property sale wouldn’t cover their mortgage and could result in default, McKay said it’s a much smaller group but one the bank is actively monitoring.
“That bucket, I can tell you, is in the low single-digit percentages of our portfolio,” he said. “And that’s the bucket we’re managing”.
To the extent these measures are implemented, further pressure on mortgage growth is likely. Mortgage brokers can access lenders not impacted by OSFI B-20 rule changes. More than ever, brokers could add value to borrowers turned away from the banks. In these uncertain times, existing and new clients need advice from a trained and caring professional.
Prohibition on the Purchase of Residential Property by Non-Canadians Act.
Summary of New Rules, 2023:
Anyone with a work visa will have to have lived here for 3 of the past 4 years and have filed taxes during those years. Here are the RULES!
- Holds a valid work permit as defined in section 2 of the Immigration and Refugee Protection Regulations, or is otherwise authorized to work in Canada in accordance with section 186 of the Regulations;
- Has worked in Canada for a minimum continuous period of 3 years within the past 4 years, where the work meets the definition set out in s. 73(2) of the Regulations; and
- Has filed a Canadian income tax return for a minimum of 3 of the past 4 taxation years preceding the year in which the purchase is made.
Please also find below the Globe and Mail article that ran last week on December 1st.. I copied and pasted the whole article:
Ambiguity about Canada’s ban on foreign home buyers creating hiring headaches for businesses
Canada’s impending ban on foreigners purchasing residential real estate is complicating how businesses hire, promote and transfer immigrant workers because of an information vacuum about the final rules.
The Prohibition on the Purchase of Residential Property by Non-Canadians Act, passed by Parliament earlier this year, will restrict foreigners from buying homes in Canada starting next month. That ban will remain in place for two years – supposedly to curb investor speculation in the housing market.
Although the legislation will come into force on Jan. 1, 2023, the federal government still hasn’t released the final regulations outlining how the prohibition will work. Those details are essential because they will specify which non-Canadians, both individuals and corporations, will be exempt from the ban.
Our legislators, however, seem unaware that 2023 is less than 30 days away. But you can be damn sure the businesses and foreign workers who have to comply with the law are acutely aware of the problem.
“The regulations will be made available soon,” Claudie Chabot, a spokeswoman for the Canada Mortgage and Housing Corporation, wrote in an e-mail. (The national housing agency led the government’s consultation on the law.)
The sooner the better. Businesses and workers are being kept on hold.
The government’s consultation paper proposed that exemptions would only be given to temporary residents who hold a valid work permit and who’ve worked in Canada for a “minimum continuous period of three years within the past four years.” Additionally, those individuals would have to prove they filed Canadian income tax returns for at least three of the four years preceding their property purchase.
That potentially sets a high bar for skilled workers. Is Ottawa really planning to prohibit executives and other talent, who plan to move to Canada with their families, from buying a home until they’ve worked here for three years?
We don’t know because the government still hasn’t finalized the rules. It’s ridiculous.
“If I’m sitting in London, England, and I’m saying, ‘Well, gee, do I want to go to Canada? Do I really want to go through all of this aggravation?’ ” said Stephen Cryne, president and CEO of the Canadian Employee Relocation Council.
Known as CERC, the non-profit organization advocates for increased labour force mobility on behalf of companies in sectors including financial services, technology, natural resources and telecommunications.
As Mr. Cryne points out, top executives who work for companies such as banks, energy companies and manufacturers have plenty of choices about where they and their families choose to live in the world.
“I was speaking with one of our members,” he recounted. “They’re looking at bringing in several executives and their families from South Africa, and [because of the uncertainty around the new rules], they’re second-guessing saying, ‘We’re not sure.’ ”
That’s hardly a vote of confidence in Canada.
CERC is asking the federal government for a blanket exemption for any foreign national with a valid work permit who is living and residing in Canada. It’s a reasonable ask.
“Given Canada’s critical skills shortages, these requirements will place Canada in an uncompetitive position when compared to other countries where such restrictions on the purchase of residential property by foreign nationals may not exist,” CERC told the government in a submission.
The proposed rules are also creating headaches for U.S. relocation management companies that handle employee moves on behalf of Canadian corporations. Some of these American companies will purchase and resell an executive’s home to speed up a move. But as non-Canadians, they could be banned from conducting such property transactions for two years – further complicating the process of relocating employees.
Not only are businesses’ hiring and relocation plans getting gummed up, the regulatory uncertainty about the forthcoming ban also risks chasing away foreign direct investment. Our immigration backlog is already a frustration for foreign companies that want to hire more employees and expand their operations in Canada.
Worst of all, it’s not clear that a ban targeting foreign home buyers will actually prevent speculation in the real-estate market.
After all, non-residents only owned 3.1 per cent of residential property in British Columbia in 2020, according to Statistics Canada. In Ontario, that figure is only 2.2 per cent.
So why is the Liberal government pointing a finger at foreign buyers for pricing Canadians out of the housing market?
This is the problem with populist policies. They might make for good politics, but they often have undesirable consequences for businesses and consumers.
The government needs to clear up the confusion about its foreign-home-buyer ban – and fast.
If Ottawa’s goal is to admit nearly 1.5 million new immigrants to Canada by the end of 2025 to solve labour shortages, it shouldn’t be giving skilled workers reasons to think twice about moving here
- The Bank of Canada (BOC) increased interest rates 7 times in 2022. Exactly as expected 16 months ago.
- Inflation is at least 5.7%; and it needs to get down to 3%
- The BoC would rather over-tighten than under-tighten
- Normally it takes 18 to 24 months for interest rate increases to work their way into the economy and we are only about 10 months into this tightening cycle
These 4 painful data points mean Prime will increase from 6.45% to 6.70% on Jan 25th.
We now expect there to be at least 1 or 2 more o.25% increases to Prime before it is expected to hold for the rest of 2023, and then begin to decrease in 2024.
Mortgage Mark Herman, Top Calgary Alberta Mortgage Broker
A lot of the recent talk in financial and real estate circles has been centering on the possibility of a pause in the Bank of Canada’s aggressive interest rate increases. Some speculate that could happen at the next rate setting, later this month, on January 25th.
The Bank raised rates 7 times last year in an effort to rein-in galloping inflation. It does seem to be working, but there are some stubborn sticking points.
Headline inflation, known as the Consumer Price Index (CPI), has dropped. It was 8.1% in July and drifted down to 6.8% in November. However, the drop from October to November was a mere one-tenth of one percentage point and the Bank’s target rate remains significantly below that, at 2.0%.
As well, the BoC’s preferred inflation measure, Core Inflation (which strips out volatile components like food and fuel), actually increased. A simple averaging of the three components that the Bank uses to measure Core Inflation came in at nearly 5.7% in November, up from 5.3% in October.
Other factors that figure into the Bank’s plans include Gross Domestic Product and unemployment. Canada’s GDP continues to grow, albeit modestly, despite rising interest rates. It increased by 0.1%, month-over-month in November. Unemployment dipped 0.1% to 5.0% in December. Both of these tend to fuel higher wages which are a key driver of inflation.
The Bank of Canada, itself, remains firmly dedicated to battling back inflation. Governor Tiff Macklem has said he would rather over-tighten than under-tighten and run the risk of having high inflation linger and become entrenched.
The U.S. central bank has made it clear it plans more rate hikes. Given the integration of the Canadian and American economies, the Bank of Canada does have to pay attention to what its American counterpart does.
The BoC will have new economic data by the time it makes its January 25th announcement. The December numbers will provide a fresh look at how well the inflation fight is going.
Normally it takes 18 to 24 months for interest rate increases to work their way into the economy and we are only about 10 months into this tightening cycle. It is reasonable to expect another 25 basis-point increase on the 25th. Given the Bank’s apparent success so far it also seems reasonable to expect a pause sometime after that.
Looking ahead to a year from now some forecasters say we might start to hear talk of interest rate cuts, which would be welcome news. Cuts would allow the BoC to move toward its, long stated, goal of normalizing rates back into the neutral range of 2.5% to 3.5%. The Bank of Canada, and central banks around the world, have been trying to do that for more than a decade – since the ’08 – ’09 financial collapse.