The Bank of Canada lowered its overnight lending rate this morning by 25 basis points from 5 per cent to 4.75 per cent. In the statement accompanying the decision, the Bank noted that first quarter real GDP growth was below forecast, and recent data suggests the economy in operating in excess supply.

On inflation, the Bank sees downward momentum in core inflation, while noting that shelter inflation remains high. Overall, the Bank is confident that inflation will continue to move toward its 2 per cent target and that monetary policy no longer needs to be as restrictive. This Bank of Canada rate-lowering cycle will be one of the few times this century that rates are being cut for reasons other than in response to a global crisis.

As such, we should expect a gradual pace of rate cuts measuring 25 basis points per meeting over the next 18 months until the Bank’s policy rate hits the mid-point of the Bank’s estimated neutral range of 2.25-3.25 per cent. Where the policy rate ultimately ends up will be dictated by economic conditions.

A good baseline is 2.75 per cent, but a worse than expected economy could mean the Bank’s policy rate needs to fall under 2.25 per cent for a period, and conversely, more stubborn than anticipated inflation could mean that this lowering cycle stalls out north of 3.25 per cent.

Now that the Bank of Canada is at long last lowering its policy rate, the impact on fixed mortgage rates may not be that significant. The bond market, and by association the mortgage market, is a machine that digests all available information about current and future economic conditions and, since late 2023, markets have strongly anticipated falling policy rates. As a result, 5-year fixed mortgage rates have likely already priced in the entirety of expected rate cuts.

As for variable rates, current market pricing has settled around prime minus 60 basis points. If that discount holds, it will take seven rate cuts or 175 basis points, before the average variable rate falls back under the average 5-year fixed rate.

Posted by Adam Chahl on
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