Market Insight with Cameron Levitt

How will the Bank of Canada’s latest rate hike affect the summer market?

The Bank of Canada has raised rates again up 25 basis points to 5% on the overnight rate. In their press release, they note that “Canada’s economy has been stronger than expected” and regarding real estate “new construction and real estate listings are lagging, which is adding pressure to prices.” While it’s clear that higher interest rates are not positive for real estate prices, the strength and resilience of the real estate market has been the real story this year. In the face of chronic undersupply, large fundamental demand, a strong economy and massive population growth this latest rate change is unlikely to have a material downward effect on prices.

While BOC hikes get all the press, it’s moves in the Canadian Government bond market that will be having the largest impact on buyer demand and sale prices for the rest of the year. The majority of buyers have been taking a 1-, 2- or 3-year fixed rate and these mortgages are priced according to bond yields which move up and down. The overnight rate certainly affects short-term rates, however the longer the time horizon of a bond the more the free market influences the price and therefore it’s yield.
Short-term yields on bonds have all made new highs for the year. So while the hikes in June & July has added another 50bps bps to a variable mortgage, the two year bond yield has moved nearly 120bps in the past five months. Not all of this change will be passed down to new mortgages, however the effect of this right now will undeniably push down the budgets for new buyers.

That being said, it’s always important to remember that the bond market is forward looking and fluctuates over time as it prices in new economic data and outlooks. There have been numerous ups and down over the past 12 months. For example, yields dropped significantly in March due to fears from the Silicon Valley bank and the regional bank stress in the United States. The bond market is currently agreeing with the Bank of Canada’s narrative that rates will be “higher for longer” but bond yields and therefore fixed rates could be very different by the end of the year.

We should also remember that pre-approvals on fixed mortgages with a rate hold can last for 90-120 days. Despite the higher overnight rate many buyers were able to secure a lower fixed rate during these periods when bonds yields trended lower. Much of the price increases in the spring real estate market were a result of buyers taking advantage of these windows of lower yields to lock in at a more competitive rate. It’s likely we are also currently seeing a push right now as active buyers who have a rate hold scramble to purchase and close prior to losing that attractive mortgage.

The biggest effect of the Bank of Canada raise is going to be felt on existing homeowners with a variable rate mortgage or other types of floating rate debt like a HELOC. The real question is if this new hike drastically swings the balance from sellers to buyers with a big supply of houses coming to the market. We remain skeptical that there is going to be a rush to the exit out of primary residences. Despite many claims that the market would inevitably fall apart with much higher mortgages, new buyers have for the most part, accepted the higher rates and moved forward with purchases. Extreme downward pressure on prices remains a fairly low probability outcome without further hikes from the BOC and a significant trend change in fundamentals of supply or the economy.

I do expect activity and prices to dip off slightly this summer from a combination of the normal seasonal slowdown and the effect of changes in rates. Typically, the summer market gets more negative press than it probably should, as bearish sounding headlines always get more views for writers vying for attention. Autumn will be a more accurate representation of the market’s health.

Over the next few months buyers and sellers should keep their eye on the bond market. If there’s a drop in yields and mortgages follow, there may be some deals to scoop up for the buyers or pockets of strength for sellers while the rest of the market is still focused on the Bank of Canada.

Written by Sales Representative Cameron Levitt

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