The on-again, off-again tariff torment from the United States is reinforcing opinions about which direction the Bank of Canada’s interest rate policy is going … down.

Market watchers say there is a 75% to 85% chance of another quarter-point drop this week. That would bring the central bank’s policy rate to 2.75%. It is more welcome news for anyone in the market for a mortgage or a renewal as First National bank reports.

Most of Canada’s recent economic news has been good. Gross Domestic Product was strong in the fourth quarter, with a 2.6% annualized increase in the value of all goods and services produced by the economy. Expectations had been for a 1.8% increase. Third quarter figures were revised upwards from 1.0% to 2.2%. GDP-per-capita – which is a measure of how well individual Canadians are doing – rose for just the second time in the past seven quarters, rising 0.02%.

Jobs have also been doing well with 211,000 positions created from November to January. Some 76,000 jobs were added in January alone. The unemployment rate is down to 6.6%.

But a corner was turned in February and a sign of weakness has appeared. Job creation collapsed to just 1,100 new positions, well below the 20,000 that had been forecast. Many see it as an early indicator of how the “management-by-mayhem” coming out of the United States is already weighing on Canada’s economy.Analysts say it gives the Bank of Canada plenty of latitude to keep dropping rates.

The Canadian economy is facing a permanent “negative structural change” if threatened U.S. tariffs become a long-term reality as per First National Bank reports.

Bank of Canada Governor Tiff Macklem issued the warning during a recent speech to business groups in Mississauga.  He also cautioned that an all-out trade war with the Americans would put the central bank in the position of fighting contradictory problems with the one, main weapon it has: interest rate (monetary) policy.

The Bank would be left trying to limit tariff-fuelled inflation by keeping interest rates high while, at the same time, trying to stimulate economic growth, which is usually done by lowering interest rates.

The BoC estimates that sweeping, 25% U.S. tariffs on Canadian goods could leave Canada in a serious recession with virtually zero economic growth over the next two years.

While Canada’s exports – mainly energy, autos, aluminium and steel – would take major hits, new home construction here would also suffer significant shocks.

Retaliatory Canadian tariffs on everything from appliances to plumbing fixtures to plastic building materials would drive up prices for builders and those costs would be passed on to buyers.  This would also be the case for the home improvement and renovation sector in the resale home market.

Broad economic uncertainty created by tariff threats, and the resulting fears about jobs, inflation and interest rates could have wide ranging negative impacts on the housing industry, which relies on confidence and stability to generate market activity.

The first significant economic report of the new year landed on Friday and it is raising speculation about the Bank of Canada’s next rate move.

Statistics Canada’s December employment numbers show nearly 91,000 new jobs were added for the month, nearly four times more than had been expected.  Most of the jobs (56,000) are full time as the First National reports.

The hiring boom dropped the unemployment rate to 6.7%, down from 6.8% in November.  The employment rate, which is the percentage of the population that is working, actually increased for the first time in two years.

The news is broadly seen as good, showing the Canadian economy is resilient and doing well as we continue to climb down from high inflation and other lingering effects of the pandemic.

Some market watchers are now suggesting the Bank of Canada may not need to make another rate cut at its next setting on January 29th.  They also point to the weak Canadian dollar, and signs that the U.S. central bank will slow its rate cutting plans, as indicators the BoC will pause.

However, a number of prominent Canadian economists point out that StatsCan’s employment numbers have a history of volatility, which make it difficult to base forecasts on a single report.  They also say the lingering threat of U.S. tariffs is weighing on business and consumer confidence, and lower interest rates could help counter that.

With the arrival of the new year comes a new round of predictions about what is ahead for interest rates, mortgages and real estate.

Generally, the mood among realtors is up-beat as First National report mentions. The Canadian Real Estate Association has tempered its forecasts but continues to forecast increases for sales and home prices through 2025.  CREA expects an active spring market.  It is predicting a 6.6% increase in sales, with nearly half-a-million properties changing hands this year, and a 4.4% increase in the national average price of a home, to $713,000.

Canada’s big realtors see a stabilizing but improving market ahead.

Royal LePage is calling for its aggregate home price to rise 6.0%, year-over-year, to nearly $857,000 by the end of 2025.

Re/Max is looking forward to a 25% increase in sales with a 5.0%, year-over-year, increase in pricing.

Falling interest rates get most of the credit for fueling a market resurgence.  Five consecutive cuts by the Bank of Canada, starting back in June, dropped the trend-setting policy rate from 5.0% to 3.25%.  But the Bank has signalled more cuts are coming and that might have some buyers holding back and waiting for even cheaper financing costs.

The lower rates do not offer the same benefits for homeowners who are renewing their mortgages.  Even with the central bank’s cuts they are still facing significant increases over the rock bottom rates they had.

The latest employment numbers have more forecasters calling for a 50 basis-point (0.50%) cut in the Bank of Canada’s benchmark Policy Rate on December 11.  It will be the Bank’s final rate setting for this year as First National Bank reports.

The November unemployment rate rose to 6.8%, up from 6.5% in October, despite the addition of 51,000 new jobs.  The increase in the jobless rate is the result of more people actively looking for work.  The, so called, participation rate has been pushed up by high levels of immigration.

High interest rates that were designed to combat inflation have led to a slowdown in hiring.  Now that inflation is back inside the BoC’s target range the Bank has been cutting rates in an effort to keep the economy moving.  Back in October the Bank tried to accelerate that process with a 50 basis-point rate cut.  Prior to that the Bank had been trimming its Policy Rate in 25 basis-point increments.

The central bank is also closely monitoring Gross Domestic Product.  GDP continues to grow, but not as quickly as the Bank has forecast.  It increased just 1.0% in the third quarter.  Expectations had been for a 1.5% increase.  Fourth quarter numbers could also be disappointing due to the nation-wide postal strike.

Another factor that will likely be part of the Bank’s calculations is the value of the Canadian dollar.  The Loonie is currently valued at about 70 cents U.S., which is a 4 and-a-half year low.  The Bank may be reluctant to see our dollar dip even further, which is a common reaction when Canada’s interest rates fall below those in the U.S.

The October inflation report caused a minor commotion but it does not appear to have upset things enough to see the Bank of Canada change course as per First National’s Bank report.

Statistics Canada reports headline inflation, also known as the Consumer Price Index, rose to 2.0%, on a year-over-year basis, up from 1.6% in September.  An increase was expected, but the October bump was bigger than forecast.  Still, inflation remains in the central bank’s sweet spot.

It is now widely expected that the Bank of Canada’s next interest rate setting, in December, will see a quarter point cut, rather than another half point reduction.

Even with less aggressive action by the BoC there is evidence that the rate cuts are working.

Two key drivers of inflation – mortgage interest costs and rent inflation – were down in October and in September, retail sales rose for the fourth straight month, increasing by 0.4% over August.  Statistics Canada’s flash forecast for October is predicting a 0.7% increase.  That would boost third-quarter retail sales by nearly a full percentage point, reversing a significant contraction in the first half of this year.

A further spending increase can be expected if the prime minister’s proposed “GST Holiday” and $250-per-worker stimulus plan is implemented.  Some market watchers are concerned the scheme could be inflationary.  They say that could keep the BoC on a slower, rate cutting schedule

Global financial markets faced unprecedented disruption when economies shut down in response to the global COVID-19 pandemic. To support financial markets, the Bank of Canada launched 10 liquidity facilities and asset purchase programs. As markets recovered from the initial shock, the central bank refocused their operations from ensuring that markets functioned to using these tools for monetary policy as mentions Kevin Fettig CEO of CMI.

Given that the Bank’s policy interest rate reached its effective lower bound of 25 basis points, quantitative easing (QE) played a pivotal role in extending the reach of interest rate reductions across the yield curve. QE involves the central bank purchasing government securities or other financial assets from the market, which increases the money supply and lowers long-term interest rates. By injecting liquidity into the financial system, QE aims to encourage lending and investment, stimulate economic activity, and support asset prices.

As a result, QE served as an additional tool for implementing monetary stimulus measures during the pandemic, leading to the Bank’s holdings of Government of Canada bonds reaching approximately $440 billion at its peak. However, starting from April 25, 2022, the Bank transitioned from quantitative easing (QE) to quantitative tightening (QT), allowing assets to gradually roll off its balance sheet. Last March, the Bank indicated its expectation that QT would conclude around the end of 2024.

The objective is to employ an abundant reserve system (ARS), also known as a “floor system,” for setting interest rates. Previously, the Bank had operated under a “corridor system,” which is characterized by scarce reserves. In this system, the central bank sets a policy rate, such as the overnight lending rate, which serves as the upper bound of the corridor. Simultaneously, the central bank sets a lower bound, typically referred to as the deposit rate or the floor rate. Banks can borrow funds from the central bank’s lending facility at the upper bound rate and deposit excess reserves at the lower bound rate. The corridor system effectively limits short-term interest rate fluctuations within this range, with market forces determining rates within the corridor.

Central banks typically use the corridor system to maintain control over money market rates and influence broader economic conditions. However, during times of financial stress or when interest rates approach zero – as they did during the pandemic – central banks may adjust their policy framework, such as transitioning to an abundant reserve system, to better achieve their monetary policy objectives.

Claudio Borio of the Bank for International Settlements notes, there are potential drawbacks to the abundant reserves approach. Firstly, there’s a greater need for the central bank to inject liquidity during periods of stress to maintain market stability. Secondly, it could contribute to collateral scarcity. Rates in the repo market, which is used by the bond market to finance bond portfolios, are heavily dependent on the supply of government securities and reserves.

In 2017, then Federal Reserve chair Janet Yellen likened the reduction of the Fed’s balance sheet to “watching paint dry,” suggesting it would go unnoticed. However, in practice, we saw stress events in the repo market in 2019, when increasing reserve scarcity hindered banks from lending in the money markets, leading to higher repo rates due to heightened demand for cash.

Recently, the Canadian Overnight Repo Rate Average (CORRA), the overnight repo rate between banks that serves as the Bank of Canada’s target rate for monetary policy, has traded above the Bank’s intended target of 5%. At times, CORRA exceeded the target by as much as 6 basis points, prompting the Bank to inject $5 billion of liquidity into the overnight market through its overnight repo operations.

Part of the challenge stems from the fact that although banks are able to hold large cash reserves since the financial crisis, liquidity requirements mandating banks to maintain minimum cash levels can limit their willingness to lend funds. The introduction of Lynx, the real-time payment system used by the Bank of Canada for implementing monetary policy, presents another aspect of the challenge. Lynx, which replaced the Large Value Transfer System (LVTS) in 2021 as part of Canada’s payments modernization efforts, is still in its early stages, and the amount of settlement balances required for the system is still being refined.

Settlement balances have decreased significantly, dropping to $112 billion from a peak of $390 billion in February 2021. The Bank has indicated an estimated target range for settlement balances of between $20 to $60 billion, while market analysts anticipate that settlement balances will stabilize at approximately $80 to $100 billion. Additionally, there is speculation that the central bank may signal the end of quantitative tightening (QT) as early as April.

Housing Affordability Watch

Despite the presence of various rent control policies across Canada, doubts persist about their effectiveness in curbing inflation in the housing market. With rent controls in place for a significant portion of the rental market, including capped increases and annual guidelines, one would expect more stability in rental prices. However, despite these measures, the rent component of inflation remains notably high.

While rent inflation is expected to moderate, ongoing pressure exists to either tighten existing controls or introduce new ones, as seen in recent bylaws targeting renovictions. Yet, economists caution against the broader implications of rent controls, citing their potential to deter new construction, reduce housing quality, and distort market dynamics. In this context, the debate shifts towards the concept of housing abundance as the most effective form of rent control, where a surplus of housing incentivizes landlords to prioritize tenant retention over excessive rent hikes.

Canada’s latest inflation numbers were not the sign anyone hoping for lower interest rates was looking for.  Headline inflation, also known as the Consumer Price Index, rose to 3.4% in December, up from 3.1% in November.  Much of the increase was driven by high rents and increasing mortgage costs as report says by First National bank.

None the less, some recent surveys suggest Canadians are adjusting to the current situation and the “Fear of Missing Out”, FOMO, appears to be shifting to TOWA – “Tired of Waiting Around”.

The Canadian Pulse Report for the 4^th quarter, from the research firm Dye and Durham, indicates only 20% of potential homebuyers are going to wait for prices to fall, and just 21% say they are going to wait for interest rate cuts, before they enter the market.

“Inflation is cooling and interest rates are stabilizing, and with that Canadians are telling us that they have renewed optimism in the outlook for their housing plans,” Martha Vallance, chief operating officer at Dye & Durham, said in a release.

That optimism is also reflected in the December Household Outlook Index from the data firm, Maru.  It suggests almost 40% of Canadians believe the economy will improve in the next 2 months, up from 33% back in October.  Canadians who intend to make big-ticket purchases edged up to 18% from an earlier reading of 17%.  Just over half say they will put money away for retirement, up from 48%.

The Bank of Canada’s 4^th quarter survey of consumer expectations indicates Canadians are keeping a close eye on inflation and the economy and are adapting, and adjusting their finances in response.

Home buyers report a variety of feelings when it comes to financing a new home. According to the 2019 CMHC consumer report, most borrowers reported feeling “happy” or “excited” about their purchase, but over one-third of borrowers also said that buying made them feel stressed. Additionally, 42% of buyers felt uncertain about the process and 28% felt anxious about home ownership.

Along with feelings of frustration and fear, it is fair to feel overwhelmed with emotion while making, arguably, your largest financial decision. While it is important to acknowledge those feelings, we want borrowers to feel confident about their decision, and optimistic about their future. This post contains a few tips on how you can reduce feelings of stress, fear and frustration during the home-buying process as mentioned by Jacqueline Kean  in Home-Trust blog post.

Budget

You can help reduce the stress around home buying by beginning with a budget. A budget can help you feel more in control of your financial situation and reduce your stress. Budgets can allow you to better balance your income against expenses, which will help you reach your financial goals faster.

The Government of Canada has budget worksheets that can help you calculate expenses, including your one-time expenses in buying a home, such as your down payment, closing costs and ongoing expenses like your mortgage payment or optional mortgage life and disability insurance. Budget planners and calculators can help you understand what expenses to expect which may reduce any fear or frustration caused by future surprise expenses.

Having a budget also allows you to allocate money toward your emergency fund. Experience from  COVID-19 has emphasized the importance of having an emergency fund to reduce financial stress, both now and for the future. As a general rule, your emergency fund should cover your expenses for three to six months.

Research

While it seems like more work up front, learning mortgage terminology before you start the process can help you prepare for conversations with your broker. For example, knowing the correct language can help you understand a mortgage pre-approval, which is when a lender examines your finances to understand what they would lend you. Over half of borrowers who plan to purchase a home in the next two years get pre-approved.[1] Pre-approval can be a good step to understanding what you can afford while you are in the early stages of buying a home.

By familiarizing yourself with mortgage terminology, you can also reduce uncertainty and stress later in the process when it comes to signing a commitment. Start with words like term, amortization and principal.

Planning

An essential part of planning is finding a mortgage broker you trust with your story. One-third of buyers received recommendations for a broker from a real estate agent, and half of customers interacted with a broker in 2019. At Home Trust, our broker partners understand that life happens, and take the time to listen to your whole story so we can work together to find you the right mortgage solution.

While buying a home can seem stressful, there is an abundance of resources, from budgeting tools, realtors and brokers that can help you through the process. By taking the time to learn more about mortgages, you can feel confident about your financial situation.