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Bank of Canada offers a reprieve for mortgage borrowers, but leaves door open to more hikes

The Bank of Canada opted to leave interest rates unchanged today but maintained its hawkish bias, confirming it won’t hesitate to hike rates further if inflation doesn’t continue to trend downward.

Markets had widely expected the rate hold, which leaves the overnight target rate at 5.00% and prime rate at a 22-year high of 7.20%.

In its accompanying statement, the bank said it made the decision due to “recent evidence that excess demand in the economy is easing, and given the lagged effects of monetary policy.”

However, the BoC added that it “remains concerned about the persistence of underlying inflationary pressures, and is prepared to increase the policy interest rate further if needed.”

Economists from National Bank noted that the “explicit threat to tighten further” was absent from the bank’s previous two announcements, where it simply said it would “continue to assess” the dynamics of core inflation.

Despite headline inflation reaching 2.8%, it crept back up to 3.3% in July. The Bank acknowledged that core CPI and inflation expectations remain a concern given that there’s been “little downward momentum in underlying inflation.”

Wanting to avoid a repeat of the spring housing surge

Economists say the Bank of Canada is trying to avoid a repeat of earlier this spring, when its rate pauses in March and April led to renewed buying activity and a premature assumption by borrowers that rates had reached their peak.

“Policymakers clearly do not want a repeat of earlier this year, when a short-lived pause sparked thoughts of eventual rate cuts, in turn firing up housing,” wrote Douglas Porter, BMO’s chief economics. “A fair question to pose now that the Bank has held steady is will the return to pause cause the housing sector to reignite, as it so vividly did this past spring?”

The answer, according to BMO economist Robert Kavcic, is “probably a lot less so.”

He argues that housing activity and upward price pressure should remain subdued for three key reasons, including the fact more listings are coming online (+16% year-over-year) compared to the spring.

“Second, there was meaningful mortgage rate relief in the spring [in part, due to the U.S. banking turmoil], especially in the shorter-term fixed space, which we’re not seeing today given where yields are right now,” he added.

And finally, he points to a softening in the economy and job market conditions since earlier in the year.

“A BoC pause will surely help market psychology, but the headwinds looks stiffer,” Kavcic argues.

Door remains open to further rate hikes

Despite the surprisingly weak GDP data for the second quarter, today’s hawkish statement from the Bank of Canada has markets upping the odds of further rate tightening by the end of the year.

Bond markets are currently pricing in 60% odds of another quarter-point rate hike by the end of the year. However, rate watchers say that figure is practically meaningless given how much it can change between now and then.

“Although the BoC has moved back to the sidelines, it doesn’t mean it will let up on its hawkish rhetoric,” noted James Orlando of TD Economics. “It needs to make sure that financial conditions remain tight for the economy to continue to slow.”

The Bank will have a better sense of how the economy is performing when employment figures for August are released on Friday, and following August inflation data, which will come out on September 19.

Featured image: David Kawai/Bloomberg via Getty Images