Unsurprisingly, the Bank of Canada has committed its policy rate to an upward move that could bring the target for the overnight rate into the 1.75-2.75% range by mid-2024.
The Bank of Canada maintains its orientation mentioned in January even if the geopolitical environment has darkened. It therefore retains, for the time being, that “the unprovoked invasion of Ukraine by Russia is a major new source of uncertainty. Oil and other commodity prices have risen sharply. This will drive up inflation around the world, and the adverse effects on confidence as well as further supply disruptions could weigh on global growth. Financial market volatility has increased. The situation remains fluid and we are monitoring its development closely.”
With the 25-point increase to 0.5% in the key rate announced on Wednesday, the so-called moderate scenario put forward by economists in January therefore remains dominant, with four increases of 25 points this year, pushing the target financing rate to a Bank of Canada daily at 1.25%. Two additional increases would follow in 2023, reaching the so-called neutral rate of 2% between the end of next year and mid-2024. It should be noted that the Bank of Canada places the neutral rate in the middle of the 1.75-2.75% range. The more muscular one outlining six hikes in 2022, pushing the key rate to 1.75% in December, then to 2% somewhere in the first half of 2023, thus loses probability in the current context of uncertainty brandishing a threat of stagflation.
On the one hand, the inflationary drift is global. It is fueled by soaring energy prices and distortions in supply chains, generating a supply shock against which the monetary authorities cannot do much. The surge in commodities prices fueled by the Russian invasion of Ukraine only adds to the problem.
On the other hand, inflation hits current expenditure more severely, meeting basic needs, such as food and housing.
Real estate vulnerability
Finally, this upward movement that is beginning must be seen in the perspective of accessibility to property which, at the end of 2021, recorded a fourth quarterly deterioration in a row. Last year, this deterioration recorded its fastest pace in 26 years, write economists Kyle Dahms and Alexandra Ducharme, of the National Bank. Across Canada, mortgage repayments on a representative home accounted for 48.6% of a representative household’s income, the worst affordability since the mid-1990s.
In Montreal, affordability fell for a fifth straight quarter to reach its worst level since 2008 and post the fastest deterioration in affordability since 1995. Mortgage payment as a percentage of income reached 38.5% for a property representative other than a condo, 26.6% for a condo. At the end of 2021, it took a representative household 48 months (at a savings rate of 10%) to accumulate the minimum down payment for the purchase of a property other than a condo, 31 months for a apartment.
In Quebec City, which claims to be the most affordable market among those covered by the National Bank’s analysis, accessibility has returned to its 2019 level. The mortgage payment for a property other than a typical condo accounted for 24.2 % of the income of a typical household, 16.2% for a condo.
Certainly, the continuous rise in prices plays a role in this deterioration. But the pressures in the last quarter of 2021 came mainly from rising mortgage rates. The benchmark five-year fixed rate rose 28 basis points, posting its largest quarterly change since the third of 2017. National analysts add that with investors now expecting key rates to rise faster, this benchmark rate has risen another 30 basis points in the current quarter, for a cumulative 100 points since the low of this rate at the end of 2020.
To illustrate the sensitivity to the cost of money in an environment of overheated real estate, let’s say that this increase of 100 basis points would be equivalent to an erosion of purchasing power of 10.7%.
Variable rate
In a context of high cost, many buyers preferred to opt for the variable rate, “in a record proportion of 53%”, in the second half of 2021, writes the National Bank. Oxford Economics calculated that between the fourth quarter of 2019 and the second of 2021, 70% of new mortgage debt was variable rate. These borrowers today feel challenged by the upward trend in the key rate that the Bank of Canada has just initiated, and this, more so among young people.
In a Desjardins Group study, it was recalled that borrowers aged 40 and over have largely used part of the additional savings generated during the pandemic to reduce their non-mortgage debt. Younger people have, on the whole, also generated more savings, without however reducing these debts, most of the surplus having been directed to real estate for those who have accessed the property. Debt in this age group has grown at a faster rate than income, which increases its vulnerability to the unexpected.