This Page's Content Was Last Updated: July 12, 2023

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- Inflation is still far higher than the Bank of Canada’s target of 2%. Bank of Canada likely has to raise its policy rate again.
- Any reduction in mortgage rates would be very unlikely in 2023.

See WOWA’s mortgage interest rate expectation/forecast in this table

Date | BoC Rate | Prime Rate | 5-Year Variable | 1-Year Fixed | 2-Year Fixed | 3-Year Fixed | 5-Year Fixed |
---|---|---|---|---|---|---|---|

2023-09-16 | 5% | 7.2% | 5.9% | 6.69% | 6.24% | 5.64% | 5.29% |

2023-12-31 | 5.25% | 7.45% | 6.15% | 6.62% | 6.1% | 5.5% | 5.2% |

This table is populated based on the information available on September 16, 2023. Use the most updated data to form your judgment for your financial decisions. In making these forecasts we have assumed the risk premium, and the term premium to stay constant and market expectation of the risk free rate to be correct. |

As of July 11, 2023, WOWA is expecting one or possibly two rate hikes of 25 basis points by the Bank of Canada and a terminal policy rate of 5% - 5.25% for this cycle. This translates into a terminal prime rate of 7.2% - 7.45%. Thus variable mortgages are likely to experience another 0.25% - 0.5% rise.

For many Canadians, mortgage payments are the most significant expense, as ¾ of household debt in Canada is mortgage debt. Using WOWA's mortgage calculator, we see that with a 25-year amortization and a mortgage rate of 6.5%, you will pay as much interest as your initial principal. If your mortgage rate is reduced to 3.5%, you will pay half the money you initially borrowed in interest over a 25-year amortization period. With a mortgage rate of 2.4%, interest would total one-third of your initial mortgage principal.

Mortgage Interest Rate | Interest Portion | Principal Portion |
---|---|---|

6.5% | 50% | 50% |

3.5% | 33% | 67% |

2.4% | 25% | 75% |

The mortgage is assumed to amortize over 25 years and to have no cost other than interest.

Thus, mortgage interest on its own is a high cost for many Canadians, and therefore, choices like having a fixed rate or a variable rate mortgage and the term of one’s mortgage contract are consequential. The most conservative option would be a fixed-rate mortgage with a longer mortgage term. For example, a 10-year fixed rate mortgage or a 7-year fixed rate mortgage. 10-year and 7-year fixed mortgages are conservative because they shield you from any increase in (mortgage) interest rates for a relatively long period of time.

By graphing interest rate vs. term, you derive what is known as a yield curve. Above, you see the yield curve of Canada's lowest fixed mortgage rates. Since 8-year and 9-year mortgages are uncommon in Canada, out of more than 50 lenders whose rates are reported by WOWA, only one lender was advertising those rates. 6-year term mortgages are also uncommon, such that only six lenders advertise them. Thus we should look at the mortgage yield curve excluding those three terms.

At this time, the mortgage yield curve for terms of five or fewer years is inverted. You can get a lower interest rate by taking a longer mortgage term. In a normal yield curve, interest rates are higher for longer terms. This is because, with a longer term, you are also purchasing insurance to protect yourself against rising interest rates. The difference between the interest rate on a long-term and the interest rate on a short-term is referred to as term premium.

Present-day curve inversion is because, in the second quarter of 2023, most market participants expect mortgage rates to decline. Currently, Canada’s short-term interest rates (symbolized by the prime rate) are at their highest level of the 21st century.

In June 2022, Canada's inflation rate reached a four-decade high of 8.1%. The Bank of Canada (BoC) was compelled to raise BoC's policy rate into restrictive territory. BoC’s policy rate determines the interest rates charged for Canadian dollars in the overnight lending market.

The overnight lending market is where banks, insurance companies, wealth managers, retirement funds, and, in short, any sizable financial player lend their excess funds against collateral or borrow the funds they require by offering good collateral. The commonly used collateral in the overnight market is Government of Canada securities like Canada's 5-year bond or Canada's 10-year bond.

By increasing the cost of borrowing for financial institutions, BoC causes those institutions to increase the cost of borrowing for consumers and potentially increase the interest rate offered to savers, for example, through higher GIC rates or higher savings account rates.

By discouraging borrowing and encouraging saving, BoC can reduce the aggregate demand in the Canadian economy. By lowering the aggregate demand, BoC reduces the firm's pricing power and thus reduces inflation.

Inflation came down from a peak of 8.1% in June 2022 to 3.4% in May 2023. Yet the BoC’s official target for inflation is 2%; thus, much work is left for the Bank of Canada to do before it can lower the policy rate to neutral. Let us see what the market expects for changes in Canada’s overnight rates.

Different (financial) institutions publish economic forecasts based on their interpretation of the available economic data. These forecasts often include their authors' expectations for future moves in the overnight rate. But perhaps the most important forecast is the expectation implicit in the money market instruments. A money market is a market where short-term debt securities are traded.

One can view expectations (implied in the money market prices) of future moves in the overnight rate as a consensus economic forecast. One can use Canada’s short-term forward yield curve, as reported by Chatham Financial. This curve is made by using the price of forward contracts with the Canadian Dollar Offered Rate (CDOR) as their underlying asset. The forward yield curve is constructed by plotting the implied CDOR rate vs. the contract's maturity.

We used the 1 Month CDOR Forward Curve to deduce the market participants' forecast/prediction of probabilities of potential rise or cut in the policy rate by the BoC.

Announcement Date | Likelihood of the BoC policy rate Staying at | is | Likelihood of the BoC policy rate Changing to | is |
---|---|---|---|---|

2023/07/12 | 4.75% | 17% | 5.00% | 83% |

2023/09/06 | 5.00% | 80% | 5.25% | 20% |

2023/10/25 | 5.00% | 52% | 5.25% | 48% |

2023/12/06 | 5.00% | 40% | 5.25% | 60% |

Data from July 11, 2023.

We agree with the market that inflation has peaked and, in spite of bumps in the road, is headed toward the target.

BoC likely hikes rates once or twice more in this cycle. If the terminal rate ends up becoming 5%, the first rate hike would likely occur in the third quarter of 2024. If the terminal rate becomes 5.25%, the first rate hike is likely in the second quarter of 2024. We think any premature rate cut by BoC can result in drivers of inflation (like a bubble in the housing market) coming roaring back.

We expect the yield curve to remain inverted (short-term rates higher than medium-term rates) well into 2024. You can also check WOWA’s detailed 2024 mortgage interest rate forecast and 2025 mortgage interest rate forecast.

This page uses forward market expectation as the basis of its prediction. Forward markets, as of July 11, 2023, are assuming overnight rates to climb until January 2024 and then slowly decline toward a trough of 2.75% in 2027. Yet the Canadian economy is quite vulnerable because of high household debt levels and because of unjustifiably high house prices in Ontario and BC. There is the possibility of a shock throwing the economy into a recession and bringing down interest rates earlier than expected and more than expected.

The calculators and content on this page are provided for general information purposes only. WOWA does not guarantee the accuracy of information shown and is not responsible for any consequences of the use of the calculator.