More rate cuts ahead: Why fixed rates will lag behind – updated strategies for this new mortgage environment.

The Bank of Canada (BOC) delivered a jumbo rate cut, reducing its key interest rate by 0.50% to 3.75% on October 23rd. This brought PRIME to 5.95% with most lenders. This is the fourth time the rate has been lowered in a row, and there has been a total of 1.25% of aggregate rate drops since BOC kicked off the rate-cutting cycle on June 5th. The peak was 5% in July 2023, so this is undoubtedly a very warm welcome for borrowers in Canada.

The market widely anticipated this move. BOC further commented that they expect additional rate cuts to be delivered as they continue to work towards keeping inflation at their 2% target.

With inflation now at 2% and Canadian economic growth running below what is expected, the BOC rationalized this more significant rate cut and will continue to monitor future data to determine how many additional cuts will be needed to bring costs to a “neutral level.” The neutral level ranges between 2.25%-3.25%, which neither heats up nor stunts economic growth and is more sustainable for the economy.

The market still expects another jumbo cut during the December meeting with another 0.50% drop.

How does the recent Bank of Canada Decision affect Interest Rates?

Variable Rate Mortgages

Lenders are expected to reduce their PRIME rate by 0.50%. The PRIME rate for most lenders will drop from 6.45% to 5.95%, which means your variable rate mortgage will decrease by 0.50%. The payment will remain the same for clients with a “fixed” payment on their variable-rate mortgages, but more will go toward the principal. For others, the variable rate mortgage payment will decrease.

A 0.50% rate decrease would reduce interest payments by about $40/month for every $100,000 balance.

HELOCs (Home Equity Lines of Credit) and LOCs (Lines of Credit)

These products are linked to PRIME as well and will also see their rate drop by 0.50%.

Fixed Rate Mortgages

Fixed-rate mortgage rates will remain the same, so your existing rate or payment will not change. Contrary to popular belief, if you’re actively looking to secure a mortgage and have been quoted a fixed rate, the recent drop doesn’t mean you’ll see an immediate reduction to the rate quote. Fixed rates are linked to the bond market, which dictates our mortgage rates. Sometimes, lenders may not pass any savings to borrowers unless rates remain low for a sustained period.

Typically, a rate decrease has a reverse impact on asset values, so we should see an uptick in demand for real estate, which would mean property value appreciation.

Why aren’t Fixed Rates moving in correlation with the BOC Announcement?

Clients often ask what happens to the fixed rates they’ve been quoted and if the recent 0.50% rate drop would be passed along to them. The answer, for the most part, is “no” with the last announcement. Fixed rates aren’t directly influenced by what the BOC does as they take their direction from the bond market. In some cases, a BOC announcement can impact the bond market, which in turn affects fixed mortgage rates. However, with the recent rate announcement, the market had already anticipated and factored in this rate drop.

Looking at the last 30 days of bond pricing history, we can see that at the end of September, bond yields for 5-year terms (the most commonly used) were sitting at 2.70% and have been trending around 2.99% for the last few weeks. This includes the significant 0.50% BOC rate discount.

Based on current data, the market has already priced in additional rate cuts for 2024 and 2025, so any additional discounts for bonds would require new data releases. Some bank economists feel that 5-year fixed rates will likely bottom out around 3.50-4.00% by the end of 2025 based on current data, which is not much farther than what we’re currently seeing.

Looking at historical 5-year fixed terms from some big banks over the last 10 years, we’re already below the average of 5.10% and unlikely to see fixed rates under 3% as we did in 2021 during Covid.

If considering a fixed rate, some additional discounts are likely but don’t expect them to come at the same correlation as the BOC rate announcements.

Real Estate Market at a Glance

For September 2024, Canada’s SNLR (sales-to-new-listings) was 51% which is a decrease from the previous month, but still signals a “balanced market,” meaning that sellers receive a reasonable offer for their homes while buyers have enough options to view and choose from. Typically, a high SNLR of 60% suggests a seller’s market meaning that buyers have very limited options to choose from. Also, a low SNLR below 40% indicates a buyer’s market, where sellers may not receive reasonable home offers over a reasonable amount of time.

Buyers’ or Sellers’ Markets?

What does the Core Data show?

GDP Growth

This measure gives us a glimpse into the health of the economy. The most recent data shows that the economy grew 0.50% in the second quarter of 2024. However, most of this growth was driven by a 1.50% rise in government spending, higher wages and higher government purchases of goods and services.

 Early estimates for September data show little to no growth, and many economists are concerned about growth. With a recent government announcement cutting immigration targets to 395,000 for 2025 and then 380,000-365,000 going into 2027, Canada’s growth projections will continue to face challenges.

 With low GDP growth, rates tend to remain low or fall to motivate investment by businesses and the government.

Unemployment

This measure gives us an idea of the % of unemployed persons in the labour force. When unemployment is too low, it can create inflation, so a rise in unemployment can be a positive sign in the current environment. 

Canada’s unemployment rate eased to 6.50% in September 2024 from the previous month’s 34-month high of 6.60%. This is the first monthly decrease in unemployment since January.

CPI (Inflation)

One of the most critical indicators for the BOC is the average price change for a market basket of consumer goods. BOC is most interested in ensuring that inflation is under control as this hugely influences their rate decisions, and they target a range of 2-3% as a benchmark for an acceptable level of inflation.

Inflation decreased to 1.60% for September 2024, down from 2.00% in August the lowest since February 2021 and well below market expectations of 1.90%. This was the 2^ndconsecutive period that CPI inflation was under the BOC target of 2%, increasing the likelihood of additional rate cuts.

Economic Forecasts

Economic forecasts are an excellent tool to understand where rates could end up. These should be reviewed cautiously as data changes very quickly, but it is very helpful in predicting what type of mortgage to consider.

On average, most big bank economists predict rates will decrease between 0.50-0.75% from where we are today by the end of 2024. The average forecast is a total rate drop of 1.75% by the end of 2025 from where we are today, with some lenders predicting rates could decrease by 2.00% by the end of 2025.

Why a Variable Rate Solution could be the Best Option Today

Anyone with a variable rate has seen their mortgage rate increase by almost 5% over the last two years and is likely very shaken by the significant impact on their mortgage payments.

With rates now on the decline and most economists seeing rate decreases in 2024 and onward, now may be the best time to consider a variable rate again. Here’s why:

• With rates likely to drop by December of this year. Taking a 5-year variable rate despite being higher today could make sense because you can convert it to a fixed term typically with no penalty (with most lenders). E.g. – Assuming average 3-year fixed rates are 4.50%+ range and 5-year variable rates are PRIME (5.95%) less 0.70% or 5.25%, the fixed rate looks more attractive right now. If we believe rates will drop 0.50%+ before the end of 2024, then you can go with a variable rate today and then re-assess by the end of 2024 and decide if it is worth converting to a fixed rate at future lower rates after the rate drops. This way, you can avoid locking in prematurely while we’re in a rate discounting environment and take advantage of a lower rate later with no penalty.
  
  Ask anyone who locked into a 3-year fixed rate earlier in 2024 how they feel about their 5.50%+ pricing now!
• If you decide to keep the variable over the longer term and apply the rate drops per bank economist forecasts described above, we can compare savings. Let’s assume:
  • 500,000 mortgage
  • Average 3-year fixed
  • Average 5-year variable rate mortgages

The interest savings over 3 years alone would be $7,600+ by going variable today.