While a slowing economy would be cause for the central bank to lower interest rates, inflation requires the bank to at least hold rates steady.srpphoto/iStockPhoto / Getty Images
The direction that mortgage rates go has for months depended on which effect of the global trade war is going to have a bigger impact: a sluggish economy or the return of inflation.
Market analysts say inflation may prove the bigger concern, and it could push mortgage rates higher and keep the Bank of Canada’s headline interest rate at the same level for the short term.
On one hand, a slowing economy would be cause for the central bank to lower interest rates, and for bond yields – which play a major role in determining fixed mortgage rates – to go down.
On the other, inflation requires the bank to at least hold rates steady and could send bond yields up.
In May, these two diverging forces materialized. The federal jobs report came in weaker than expected, with unemployment rising to 6.9 per cent in April. The numbers could be even worse than they seem because they included thousands of temporary hires for the April 28 federal election.
Meanwhile inflation was hotter than expected. The overall inflation rate did drop to 1.7 per cent, but that’s largely owing to the federal consumer carbon levy being scrapped. Core inflation – which strips out volatile items such as food and energy costs – remained high at 2.9 per cent, and grocery inflation was higher than expected at 3.8 per cent.
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Bank of Montreal chief economist Douglas Porter said markets were pricing in only 30 per cent odds of a rate cut after those reports, down from roughly 50 per cent earlier in the week.
Analysts had largely expected another three interest rate cuts this year, but Mr. Porter now only expects one or two rate cuts in 2025, meaning higher rates for variable-rate mortgage holders.
“The bank has said their policy cannot fix a trade war, and ultimately they are an inflation targeting central bank, so one could make the case that upward pressure on inflation is what they’d be concerned with first and foremost,” said Mr. Porter.
David Larock, a mortgage broker and owner at Integrated Mortgage Planners in Toronto, said bond markets have also reacted strongly to the inflation numbers, with the Government of Canada five-year bond yield – the most consequential one for fixed mortgage rates – climbing to three per cent last week, a level not seen since January. The yield has since settled closer to 2.9 per cent.
“That is putting upward pressure on fixed mortgage rates,” said Mr. Larock, who added that an increase in U.S. bond yields in reaction to the Trump administration’s budget bill has also pushed Canadian yields up.
Long-term mortgage rates have seen modest upticks in the past month, with the lowest available five-year rate on Ratehub.ca rising from 3.64 per cent to 3.84 per cent, and further hikes could materialize.
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Benjamin Tal, deputy chief economist of CIBC World Markets, said that while U.S. President Donald Trump’s rhetoric around trade disputes has calmed somewhat, there is still a lot of uncertainty in the air.
Mr. Tal said monetary policy can’t fight a trade war, but he believes it can help the situation and said there is a case for the Bank of Canada to actually cut rates more to spur economic growth.
Mr. Porter agreed that a long-term threat of a trade war, especially one with strong impacts on Canada’s auto sector, could force the central bank to lower rates.
In the short term, however, Mr. Porter sees lower odds of interest rate cuts and elevated mortgage rates.
“It’s going to be a challenge getting Canadian five-year bond yields any lower in the near term,” said Mr. Porter, adding that any path to lower yields and lower mortgage rates is not necessarily a clear one.