Canadian Mortgage Rates Peaked, Won’t Go Back To 2019 Levels: BMO

North American interest rate hikes are now largely out of the picture, and rate cuts are the new story. That was the take from BMO after the Bank of Canada (BoC) announced a hold on the 6th, with the US Federal Reserve expected to do the same on the 13th. Now the question on everyone’s mind is, how much will rates be cut? 

“First and foremost, the market has already moved to price in earlier and more aggressive easing next year, so the bar has already been set,” warns Robert Kavcic, a senior economist at BMO. 

Canadian Mortgage Rates Have Peaked, Easing Being Priced In

Markets are generally efficient, so the anticipated rate cuts have largely been priced in. Aggressive easing is already expected, with the BoC forecast to cut by 100 basis points in 2024, with the first 25 bps cut in April.  

The bond market is already moving to reflect those expectations, with mortgages to follow. In recent days, the 5-year GoC yield has already printed a decline of 100 bps since peaking in October. That means 5-year fixed rate mortgages are likely to follow in the coming months as funding costs move lower too.  

Even a mild pause in rates earlier this year stimulated the market, but sales remain slow today. The full effect has yet to trickle down to the mortgage market, but rates still aren’t as low as they were back then. 

“We’re not yet at levels consistent with those that stoked the market in spring 2023, as affordability is still very stretched at rates in the mid-to-high 5% range,” explains Kavcic.  

“A 4-handle [a mortgage rate that starts with 4] would make home buying more attainable for Canadians.” 

Interest Rates Are Unlikely To Fall Back To Pre-Pandemic Levels 

BMO believes fixed-term mortgage rates with a 4-handle is when affordability might improve. Those waiting for a mortgage rate that starts with a 2 might be disappointed. “…we continue to believe the neutral rate is higher than the past decade, so eventual rate cuts should ultimately land at a higher floor,” says Kavic. 

The neutral rate is the level where interest rates are neither inflationary or restrictive. A central bank’s goal is to hit both the target interest rate, and a neutral policy rate. 

In Canada, most are used to a neutral policy rate of 2 points. It’s been fairly normal since the Global Financial Crisis (GFC), but that’s now proving to be an exception—not the rule. The neutral policy rate in nominal terms is now forecast around 2.5%, meaning funding costs are slated to be 25% higher than most people have come to expect.   

It’s also worth emphasizing that expectations are for 100 bps in cuts over the next year. The overnight rate would remain much higher than neutral, and funding costs would remain double the rate people are used to. The cuts may provide some gas for the market, but few are expecting rocket fuel. 

Regardless of the direction, expectations aren’t reality. 

“… finally, it’s not lost on us that the market has been wrong before, prematurely calling the peak of this tightening cycle more than a few times,” says Kavcic. 

Adding, “ In fact, Friday’s U.S. payrolls report for November was hardly the stuff of Fed easing.”