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Omicron impact on mortgage rates

Omicron Has Some Doubting Current Rate-Hike Forecasts

The arrival of the Omicron variant has some paring back Bank of Canada rate hike forecasts for this year.

While bond markets continue to price in five quarter-point rate hikes in 2022—which would bring the overnight rate to 1.50%—others say that’s unlikely.

“Investors are paring back bets for rate hikes in 2022 amid Omicron concerns,” wrote analyst Ben Rabidoux in his monthly Edge Analytics report.

He noted that the 5-year bond yield, which typically leads fixed mortgage rates, has fallen about 30 basis points from its recent highs in October.

In an opinion piece published on CMT, Rabidoux argued that elevated debt levels will limit the Bank of Canada’s ability to hike rates going forward.

He noted that, including non-financial businesses, the combined debt-service ratio currently stands at 23%, a total debt-to-GDP equivalent of 240% of GDP, which is 66 points above the G20 average.

“This level of indebtedness is exactly the sort of limiter that will make it very difficult for the Bank to normalize interest rates,” he wrote. “Instead, [the Bank of Canada] will likely be more inclined to let prices run hotter than they have in previous cycles and allow inflation to eat away at the burden of debt over time.”

In a recent blog post, mortgage broker Dave Larock, of Integrated Mortgage Planners, agreed, arguing that debt levels will make it more difficult for the Bank of Canada to hike rates relative to previous rate-hike cycles.

“The Bank has averaged six hikes over its typical cycle and, late in his term, former BoC Governor Stephen Poloz acknowledged that our record-high household and government debt levels will magnify the impact of future hikes and likely reduce the total number needed to bring inflation to heel,” Larock wrote.

“Despite those facts, the bond market continues to price in five quarter-point rate hikes next year and two more in 2023. I still think that outcome is highly unlikely,” he continued. “Our policymakers have combined record amounts of fiscal and monetary policy stimulus to preserve our economic momentum throughout the pandemic. That approach, as expensive as it was, appears to have worked, so why kill that hard-earned momentum with aggressive rate hikes now?”

What would that mean for borrowers?

Larock added that should the Bank of Canada adopt a more gradual and less-severe tightening pace, that would likely lead to Government of Canada bond yields remaining below their recent peak and dropping in the coming months.

“That portends lower, not higher, fixed rates over the same horizon,” Larock wrote.

For those considering a variable-rate mortgage, rate hikes are still likely on the horizon. “I still think that anyone who either already has or is contemplating taking out a variable-rate mortgage should prepare for rate hikes to come,” he added. “I think we will see fewer increases than the bond market is currently pricing in, but some increases are inevitable.”

And there are plenty of homebuyers opting for variable rates these days.

Citing Bank of Canada data, Rabidoux noted that variable-rate originations are up 84% compared to a year ago, while those opting for a fixed rate have fallen 52%.

The current share of outstanding mortgages is now more than 26% for variable-rate mortgages, the highest level since the data was made available in 2016, Rabidoux added. That’s because discounted 5-year fixed rates have now broken above 2.50%, a 100-bps increase from 2020 lows.

Meanwhile, variable rates remain near record lows at a spread of nearly 140 bps compared to fixed rates.

Bond yields retract, some lenders cut rates

Bond yields have fallen from their recent highs, leading to some lenders cutting rates in the past week after a series of hikes. Five-year fixed bond yields reached a high of 1.48% earlier this month, but have since retreated to about 1.28%.

As a result, a number of lenders that had recently hiked fixed mortgage rates, including RBC, have had to reverse some of those hikes. Earlier this month, RBC had hiked its advertised 5-year fixed rate to 3.04%, but has since dropped it back to 2.94%.

Interest Rate Forecasts from the Big 6

Below are the latest rate forecasts from the Big 6 banks. Averaging the forecasts, the Big 6 banks expect the overnight rate to rise about 1% by the end of 2022, meaning four quarter-point rate hikes by the Bank of Canada.

Looking ahead to the end of 2023, the big banks are calling for an additional three rate hikes, bringing the overnight rate to 1.75%.

Target Rate:
Year-end ’21
Target Rate:
Year-end ’22
Target Rate:
Year-end ’23
5-Year BoC Bond Yield:
Year-end ’21
5-Year BoC Bond Yield:
Year-end ’22
BMO 0.25% 1.25% NA 1.45% 1.80%
CIBC 0.25% 1.00% 1.75% NA NA
NBC 0.25% 1.50% 1.75% 1.40% 1.90%
RBC 0.25% 1.00% 1.75% 1.25% 1.65%
Scotiabank 0.25% 1.25% 2.25% 1.50% 2.05%
TD Bank 0.25% 1.00% 1.75% 1.35% 1.90%