Examining Mortgage Rate Forecasts

In early October 2023, Canadian five-year bond yields surged to a peak not seen in 17 years, hitting 4.42 percent. However, these yields plummeted by over 100 basis points within the following four weeks. This significant shift in borrowing costs has been sparked by unexpectedly positive inflation data in both the United States and Canada, starting in early autumn and persisting through the end of 2023. As a result, financial markets adjusted their expectations regarding the timing and scale of monetary policy adjustments by the Bank of Canada, anticipating more aggressive rate cuts in the near term.

Although bond yields saw a slight uptick in February, the ongoing trend suggests that the five-year fixed mortgage rate could hover around 5.2 percent. This rate closely mirrors the current average offered rate among major lenders and falls in line with earlier projections for the end of 2024, albeit arriving sooner than anticipated. Meanwhile, discounts on variable rates have risen from prime minus 30 basis points to prime minus 60 basis points, leading to a modest decrease in average variable rates. However, a more significant drop in variable rates is expected to await action from the Bank of Canada. It's anticipated that once the Bank initiates rate cuts, variable rates could decline by approximately 100 basis points by the year's end. 

In the last quarter, Canada's economy barely grew, avoiding a recession, but it is still struggling overall, with measures like real GDP per person and spending by companies and households showing declines. However, the job market remains surprisingly strong, with consistent monthly job growth, although not keeping pace with population expansion. Despite an unemployment rate slightly higher than pre-pandemic levels, wages have been increasing by over 5 percent for three consecutive months, significantly outpacing inflation. Below are graphs which explain this in further detail.

Despite financial markets showing some over-excitement by pricing in six rate cuts by the Bank of Canada at the end of 2023, it is highly probable that the Bank will indeed start lowering its policy rate this year. There's consensus forming around the idea that the Bank will cut rates by 2.5 percent, or 250 basis points lower than current levels. The main uncertainty lies in when the Bank will make its first rate cut, with market probabilities strongly indicating a 25 basis point cut at the June meeting, followed by a high likelihood of 100 basis points of cuts by the end of December. However, the Bank has clarified that further progress, particularly in bringing core inflation below 3 percent, is needed for policymakers to be confident they are not acting prematurely. With core inflation dropping notably in February and the Canadian economy moving slowly, there's a possibility of a rate cut in April, and if not then, almost certainly in June.