The Bank of Canada is maintaining its pause, but the accelerated deterioration of economic activity and the financial health of individuals and households raises the question. When will interest rates fall?
Economists’ forecasts listed by the Bloomberg agency speak of a reduction in the key rate targeting the start of the decline in the second quarter of 2024 with an overnight target rate returning to 3% in the second quarter of 2025. On the financial market exchange contracts, known as swaps, we expect at least three reductions by next October, with a target rate reduced to 3.5% at the end of 2024 compared to 5% currently. On the bond market, traders are getting more excited these days with a first decline expected no later than March, followed by three others the rest of 2024. And we note that the extent of the decline will essentially depend on the performance of the labor market.
That’s the consensus. But for economist David Rosenberg, there is no doubt that the Bank of Canada will have to reduce its interest rates faster and more sharply than the consensus forecasts to deal with the shock of mortgage renewal, which threatens a fifth of Canadian disposable income. Nothing less ! The founder and president of Rosenberg Research estimates that the institution will reduce its key rate by two percentage points within 12 to 18 months, to bring it down to 3%, with a downward movement starting as early as the first quarter of 2024, according to comments collected by Bloomberg last month.
In his report, David Rosenberg emphasizes that the central bank no longer has a choice. The former economist of the brokerage firm Merrill Lynch, who predicted the American real estate crash of 2008, already expects a severe recession… According to him, the Bank of Canada cannot remain insensitive any longer to the fact that approximately two-thirds of the value of mortgages in Canada will mature over the next three years. As an illustration of the effect of monetary tightening, if rates remained at their current level, the average monthly mortgage payment would be expected to increase by 15% in 2024, by 30% in 2025 and by 45% by end of 2026. The accumulation of these additional interest payments would result in a 20% reduction in Canadian disposable income by the end of 2026, which would not be without translating into a sharp drop in discretionary spending and, in turn, , domestic demand.
And even if households take measures to avoid these additional payments – extension of the amortization period, additional down payment reducing savings, sale of the property, default of payment, etc. – all these avenues will only undermine the economic activity, he adds.
At Mouvement Desjardins, economists draw a similar observation, with a few nuances. “Rate increases are likely to weigh considerably on household portfolios over the coming years. If the trajectory of interest rates predicted by the markets is confirmed, borrowers in the worst situations could see their monthly mortgage payments jump by more than 70%. »
Real estate recession
The first major sector affected, the real estate market finally entered recession. Residential sales have fallen 45% since peaking early in 2021. Activity is even more depressed on a per person basis, falling to its lowest since the 2008-2009 recession. And it is expected to deteriorate further by the first half of 2024 with interest rates remaining high and supply expected to flood the market, noted CIBC analysts. They expect a decline of 10 to 15% in prices by the end of the first quarter of 2024. These prices were inflated by the small number of new registrations in 2022 and early 2023, they recalled. However, the trend has reversed, with a 31% increase in new registrations since March 2023.
At TD, we now believe that the average house price will fall twice as much as expected, with the projected correction now amounting to 10%, we read in a research note relayed by the Posthaste blog. The start of the downward trend in the rate should avoid more pronounced falls. Which would not prevent this average price from remaining 15% higher than the level before the pandemic.
A look at the bond market
Mortgage rates with longer maturities are, however, influenced by the price of money on the bond market. Persistently high inflation has caused TD to raise its bond yield forecasts. “As this translates into even higher fixed mortgage rates, more potential buyers could be priced out. Those who stay will have more bargaining power due to the increase in new registrations. »
“It is possible that mortgage rates will fall sooner if the Bank of Canada begins to suggest that reductions in the key rate are imminent,” emphasize the economists at Desjardins. With the looming low prices, the Desjardins Affordability Index suggests an overall improvement in homeownership accessibility. “But prices should remain high compared to the last two decades, especially in a context where interest rates are high. The improvement is therefore likely to be modest, so that most of Canada’s main housing markets will remain less affordable than before the pandemic. »
And they are not without reminding us that “demographic growth, on a scale not seen in decades and which accelerated further in the last quarter, continues to play a very important role in the demand for housing”.