Bank of Canada Posts Largest Rate Hike in More Than 20 Years

In a move that was larger than expected, the Bank of Canada hiked its target for the overnight lending rate to 2.5% while continuing its policy of quantitative tightening.

With inflation persistently coming in well above the Bank’s expectations and expected to remain high in the near term, the Bank raised rates by 100 basis points, which according to the Governing Council was done “to front-load the path to higher interest rates”.

This was the largest rate increase since August 27, 1998.

That said, the “front-load the path” statement suggests the July rate hike may be balanced by smaller hikes later this year. Financial markets are currently pricing in further interest rate hikes for all announcements over the remainder of the year, with rates expected to hit 3.5% by the end of 2022 – mostly unchanged from before this month’s announcement.

The Bank noted several ongoing factors contributing to stronger inflation, stating, “while global factors such as the war in Ukraine and ongoing supply disruptions have been the biggest drivers, domestic price pressures from excess demand are becoming more prominent.” The Bank highlighted excess demand in Canada’s economy, tight labour markets, record low unemployment, labour shortages, and increasing wage pressures as domestic drivers of inflation.

The Bank also observed that with consumer and business expectations of inflation to remain higher for longer there’s an elevated risk inflation could become more rooted and difficult to combat. The Bank does not expect inflation to return to its 2% target until the end of 2024.

The Bank estimates Canadian economic growth was 4% in the second quarter of 2022 but is expected to slow due to a pullback in consumption and housing. Looking further ahead, the Bank’s expectations for Gross Domestic Product (GDP) growth in the Canadian economy is now 3.5% for 2022, 1.75% in 2023, and 2.5% in 2024, with growth forecasts revised considerably lower this year and next compared to the Bank’s previous outlook published in its April Monetary Policy Report.

What does this mean for mortgages?

Canada’s major chartered banks are currently advertising five-year fixed mortgage special interest rates of around 4.81%. Home buyers can often negotiate the interest rate for mortgage financing based on their creditworthiness and the degree to which they do other banking business with the mortgage lender.

With the minimum qualifying rate for all mortgages being the greater of the mortgage contract rate +2% or 5.25% as set by the Office of the Superintendent of Financial Institutions and the Department of Finance, the stress-test hurdle in the fixed-rate space is now close to 7% for new borrowers. All mortgage applicants must qualify for financing based on an interest rate no less than the benchmark five-year lending rate, even if the mortgage is for less than five years.

The Bank of Canada’s next scheduled interest rate announcement will be on September 7, 2022. The next full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in its Monetary Policy Report on October 26, 2022.

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