Mortgage Rate Forecast Canada 2023 – 2024

The final 2023 Bank of Canada interest rate announcements are on:

Wednesday December 6

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Historical context: Mortgage rates in Canada are forecasted to gravitate towards historical lows for the long term of 5 – 10 years.

To help determine mortgage rate forecast, one of the best perspectives we have available is a historical one.

During the great recession of 2008, the financial system and economy as a whole required bailouts and stimulus as never before seen, just to keep running. Thankfully, the stimulus did its job, and the economy rebounded and got back on track. However, between 2008 – 2019, for over 10 years, there was very low or stagnant GDP growth, and interest rates remained low accordingly. 

During the ecovid pandemic, in 2020 – 2022, we witnessed a similar massive economic bailout. This time the stimulus was far greater, with over 40% of dollars ever created between 2020 – 2022. 

However, in part due to a literal shutdown of the economy and of supply chains at one point and difficulty rebooting these supply chains, combined with excess consumer demand from pandemic savings, there is much more inflation as the economy stabilizes.

This inflationary difference will be discussed in more detail below. However, the main point here is that historically, when a massive new government and private debt are layered upon already massive debt, this can perpetuate dependence on yet ever cheaper debt to stimulate the economy long term. It can lead to long term economic stagnation and, importantly, to a ‘magnifying effect’ of increased rates. 

More specifically, with 5 times more debt in the economy today, adjusted to inflation, than in the 1980s and early 90s, a single 0.25% rate increase makes an approximately 5 times bigger impact than it did when debt levels were a fraction of current levels. Accordingly, there is significant long term pressure for rates to remain low. 

From another historical perspective, when rates increased in the 1980s from a base point of 10% to a 20% high point, this represented a 2x rate increase. However, a rate increase in 2022 – 2023 from a base point 0.25% to 5% represents a 20x rate increase, which will have a much greater shock to the economy.

Finally, the ‘neutral rate‘ or ‘target rate’ at the Central Bank of Canada, which is the rate seen as neither repressing nor stimulating the economy, is currently 2.5% – 3%. Given this, we may have 2% of Central Bank rate decreases in store (5% current down to 3%), and this, too, infers fixed and variable rates to stabilize in the high 3% range.

As of October 2023, the market consensus on the mortgage rate forecast in Canada is for the Central Bank to hold the prime rate at 5% at its October 25, 2023 meeting and will continue to hold until inflation is closer to 2%. 

As of January 25, 2023 the Central Bank of Canada has indicated a conditional pause on increasing the prime interest rate.  More specifically, this pause was conditional on economic activity and inflation declining over the first half 2023. However, as of March and April 2023, there were signs that the economy and inflation were accelerating. This has caused the Central Bank to reconsider how much hiking will be enough to tame inflation.

The main tool we have when reading the current mortgage rate market is the Government of Canada Bond Yield. The Canadian bond is a government debt security that pays a return to an investor. The ‘%’ based return is called the ‘yield’ and is considered one of the safest investments because the Government would have to go bankrupt for it not to pay its investors. 

The Government of Canada 5 year Bond Yield factors in all known economic data on a day to day, and even a minute to minute basis. Simply put – when the market/ bond traders think that the Central Bank of Canada will increase rates, the Bond Yield increases. When the Bond market thinks the Central Bank rate will decrease, then the yield drops. In other words, the Bond yield trades or is priced in anticipation of where the Central Bank of Canada rates will move. The Central Bank of Canada makes its rate decisions based on how it sees the economy performing.

Currently, as of October 22, 2023, as seen in the Yield chart below, the Canadian Bonds are pricing in a pause in the Central Bank of Canada rates in the second-half of 2023. The market is also pricing in the first Bank of Canada rate drop in Summer 2024.

Ultimately, the Bank of Canada is determined to get the job done by cooling the economy and reducing inflation closer to the 2% range, so we expect the bond yield to revert lower towards the end of 2023/ early 2024.

A slowing economy, lower inflation and lower Bond Yields. What does this mean for mortgage interest rates?

With lower spending comes a slowing economy, lower inflation, and eventually, lower mortgage interest rates.

Current high rates will lead to lower rates – by design.

As of October 2023, big banks have a growing consensus that a recession in Canada will officially happen in late 2023 or early 2024. Based on the surprisingly low GDP data that came out in October, it looks more likely the Banks are correct about the recession forecast. Some leading economists point out that if we look at GDP per capita, Canada is already in a recession. More specifically, given this per capita measure there has been 4 quarters of economy/GDM. Given this, Canada has seen no Real GDP growth (economic growth after accounting for inflation) since 2018.

As consumer demand drops for goods and supply chains improve, prices of economic inputs such as copper, steel, silver, lumber, microchips, shipping costs and many other commodities have fallen drastically. These trends are very anti-inflationary. However, food costs continue to be inflationary, with energy/gas costs also generally higher. With a slowing economy, there likely will be a point later in 2023 or early 2024 when these more inflationary areas of the economy cool off.

It is known in economics and recently mentioned by the Central Bank of Canada that it takes 12-24 months for a single interest rate hike to ‘trickle through’ or have a full effect on slowing an economy. While the first small 0.25% interest rate hike in Canada happened in March 2022, as of September 2023, we have not seen the full effects of the rate hikes of 2022. More likely, we have only seen about half of the potential effects of current Central Bank interest rate hikes.

As 2023 comes to a close, we will likely see the effects of last year’s increases build momentum.

So it is important to keep in perspective that:

(1) The previous rate hikes we have seen have not had their full effect on slowing the economy, and we are already seeing a recession on the horizon.

(2) It is a matter of how long Canada can withstand such high rates before there is a significant negative economic impact.

Accordingly, the question is becoming more about how long these high rates will remain. The unfortunate answer is likely until the economic resilience we have been witnessing in discretionary spending is suppressed.

Once the economy slows to the point of recession, there is a better potential for inflation to drop to 2%, and at this point, there is an expectation of a sustained rate drop cycle. As of October 2023, the financial markets think it will take about 9 months. However, it could very well take more or less time.

So, what does this mean for mortgage rates?

What goes up to slow the economy will eventually come down to stimulate the economy.

The Central Bank of Canada (and the Federal Reserve in the USA) is determined to fight inflation, which is why they are seen as slamming the breaks on the economy as a whole. There is no doubt this, unfortunately, will be painful for many. However, low inflation is needed on a foundational level to enjoy another long-term run of low interest rates.

Eventually, the Central Banks will begin lowering rates again to stimulate the economy and pull us out of the recession. This means lower mortgage interest rates.

More specifically, after the Central Bank has reached its peak or ‘terminal rate’, historically, it takes on average 6 months for the Central Bank to start lowering rates again. However given the stickiness of current inflation, instead of increasing rates further, the Central Bank may decide to leave rates at 5% for longer.

In October 2023, Bond markets are projecting the first Central Bank rate drop in July 2024.

At this point, the expectation for the first Bank of Canada interest rate drop is projected out long enough that financial markets are essentially saying that they are waiting for conclusive evidence of a recession or major economic slowdown. In other words, markets may have gone from being overly optimistic, anticipating a rate drop, to a more cautious ‘wait and see’ type position. Given the current economic data,  a recession could happen at any point in late 2023 or early 2024, prompting a sudden drop in bond yields and fixed mortgage rates.

It’s important to note that once rates begin to fall – this can spur inflation again. For this not to happen, the job market likely needs to cool further or for a more substantial correction.

Also, Canada needs to work in step with the US economy and their Fed rates. Otherwise, the Canadian dollar could sink substantially, which can cause inflation. In other words, even though Canada will likely enter recession before the US, the Central Bank of Canada may hold out a bit longer to drop the overnight rate, until a US recession is imminent.

While the variable rate mortgage is directly affected by the Central Bank decisions, we will likely see 3-5 year fixed rates generally trend lower in late 2023/early 2024. Because fixed rates are ‘pegged’ to the Government of Canada Bond Yields and Bond Yields trade in anticipation of Central Bank rate decisions, we will likely see rates float lower, but not in a straight line.

For example, fixed rates were mostly in the high 5% range in November – December 2022. But then dropped to the mid 4% range throughout January 2023 and remained in this range through to mid May. In June, fixed rates have mostly trended back into the 5% to low 7% range (depending on the term selected), as bond yields priced in the first rate drop further out into 2024.

It’s not a matter of if, but when there is another significant downturn for fixed rates, and as of October 2023 we may have another 2 – 6 months until lower fixed mortgage rates. 

Rates will not normalize at the lowest levels seen during covid. However, as fixed mortgage rates generally remain in a restrictive 5-7% range, the expectation is that rate normalization may occur into the mid-high ‘neutral rate’ range or in the high 3% – low 4% range for mortgage rates.

The CIBC Capital Markets projection from April 2022, seen just below, illustrates a good representation of this forecasted rate trend. However, given stubborn inflation, the Central Bank rate peak will clearly be higher than in the numbers indicated in the chart:

Major Bank Prime Interest Rates Canada

Central Bank of Canada Prime Rate

5%