Inflation Data ‘All Clear’ for Bank of Canada Interest Rate Cut in June, Economists Say
With inflation cooling to a three-year low in April, some economists are now all but guaranteeing that the first interest rate cut of the Bank of Canada’s tightening cycle will come in June. The most recent data from Statistics Canada revealed that Canada’s annual inflation rate fell to 2.7 percent in April, down slightly from 2.9 percent in March.
Andrew Grantham, executive director of economics at CIBC, indicated that this data “provided the all clear” for the Bank of Canada to begin cutting rates. At the time of the April interest rate decision, Bank of Canada Governor Tiff Macklem had stated that policymakers were encouraged by recent subdued inflation readings, but needed those to persist for longer before cutting interest rates. Grantham notes that since April, there have been two more months of data pointing to tame underlying inflation, making a rate cut in June highly likely.
Andrew DiCapua, senior economist at the Canadian Chamber of Commerce, echoed this sentiment, asserting that the latest data should give the Bank of Canada more confidence that inflation is stable. He described a rate cut in June as not just possible, but the main consideration.
Tu Nguyen, an economist with RSM Canada, added that a June rate cut is now a “no-brainer.” She emphasized that with the economy lagging and headline inflation falling within the 1-3 percent range for the fourth consecutive month, there is little reason for the Bank of Canada to delay until July. She highlighted that April’s data sent a loud and clear message that disinflation is here to stay.
Douglas Porter, chief economist with the Bank of Montreal, described the recent inflation readings as more of what the “doctor ordered.” The key measures of core inflation all dipped below three percent, falling back within the Bank of Canada’s comfort zone of one to three percent. Porter believes that the door is open for a rate cut and has been anticipating a June move for the past six months. However, he noted that any cuts would be gradual due to a cautious U.S. Federal Reserve acting as a limiter on how far and fast Canadian rates can fall.
Despite the positive news, some challenges remain. Randall Bartlett, senior director of Canadian economics at Desjardins, pointed out that shelter costs are still burdening Canadians. The Statistics Canada report found shelter prices up 6.4 percent year-over-year, with inflation excluding shelter slowing to just 1.2 percent. Rising shelter costs, combined with recent increases in gasoline prices due to higher oil prices, continue to strain household finances.
Not all economists are convinced a June cut is certain. Leslie Preston, managing director and senior economist at TD Bank, is among those expecting the first cut to come in July. She argued that inflation still remains a bit high for comfort and expects the Bank will want more confirmation before taking rates lower. While markets have found April’s inflation numbers reassuring, increasing the odds of a June cut, Preston believes the Bank will likely wait until July.
Olivia Cross, North America economist at Capital Economics, also sees June as a possibility but does not rule out a July decision. She emphasized that the continued resilience of the labor market means the Bank of Canada may be comfortable waiting until July to observe two more months of inflation data.
As the debate continues among economists, the question remains: Will the Bank of Canada seize the moment to cut interest rates in June, or will it wait for further confirmation in July? The answer could have significant implications for the Canadian economy and household finances. What are the potential risks and benefits of acting sooner rather than later? And how will this decision shape the economic landscape moving forward?
Waiting for Warmth: Housing Sales Slump as Spring Blooms
Like the famous cherry blossom trees in Toronto’s High Park, the Canadian housing market tends to bloom in the spring, peaking in late April and early May. This year, however, while the cherry blossoms bloomed on schedule, the housing market remained sluggish, awaiting the warmth of an economic recovery. An anticipated interest rate cut in June could potentially provide the boost it needs.
The latest data released by the Canadian Real Estate Association (CREA) revealed that sales in April were 1.7 percent lower than the previous month. Housing sales have been consistently below the 10-year monthly moving average since the Bank of Canada initiated rate hikes in early 2022. This prolonged downturn in sales highlights the significant impact of higher interest rates on buyer activity and market dynamics.
Interestingly, this decline in sales coincides with a surprising rise in inventory. CREA reported an almost three percent month-over-month increase in new listings across Canada. However, this national average masks major swings in individual markets. In Toronto, Canada’s largest real estate market, there were 47.2 percent more listings in April than in the same month last year. With a record number of properties listed for sale across the country—the highest since the onset of the COVID-19 pandemic—buyers now find themselves in a favourable position. This market imbalance empowers buyers to negotiate more effectively, while forcing sellers to temper their expectations.
Taking a longer-term view, there is a promising trend. Compared to April 2023, sales last month were up by 10.1 percent. Housing transactions have maintained an upward trajectory since early 2023 despite some fluctuations along the way. This suggests a robust recovery is possible if interest rates remain supportive through the summer.
What about prices? Instead of comparing average prices over time, the CREA Home Price Index Benchmark Price provides a more nuanced view. This quality-adjusted estimate accounts for changes in the structural types and sizes of homes sold over time. In April, the benchmark price for Canada remained flat month-over-month and declined by 0.6 percent compared to the previous year.
Regional differences are also notable. Most real estate markets in the Maritimes demonstrated strength, with noticeable price increases. In Moncton, prices were up by 12.2 percent year-over-year, and Halifax saw a 4.3 percent increase. In Quebec, benchmark prices rose by 3.3 percent in Montreal and 7.2 percent in Quebec City. Housing markets in the Prairies and Rockies have also shown price recovery, with benchmark prices increasing by nearly 10 percent in Calgary and by 5.6 percent in Edmonton.
In contrast, the housing market in Greater Toronto continues to show signs of weakness. April prices were down slightly from the previous year. Like Vancouver, where prices were up by 2.7 percent year-over-year, Toronto has experienced significant price swings in recent years. Prices rose sharply at the start of the pandemic and then declined in 2022 as interest rates started to climb. Toronto’s relatively high prices mean an upward trend is more contingent on a reduction in mortgage rates.
The Canadian housing market is highly differentiated by location and product type, with significant variations even within local markets. The regional housing market in Greater Toronto illustrates these nuanced outcomes. This market is divided between the City of Toronto, often referred to by its area code 416, and the surrounding suburban housing markets, known as the 905.
The 416 market is dominated by condominium sales, which reported a 9.5 percent decline in April compared to the previous year. In contrast, condo sales in the 905 market declined by just 0.4 percent. The suburban markets are dominated by detached housing, with sales down by 9 percent in April compared to April 2023. The bottom line is that condo sales are struggling in central Toronto, while low-rise sales face challenges in the 905 suburbs.
John Asher, co-founder of a Toronto-based self-directed real estate platform, sees stronger headwinds for the condominium market in Toronto. He has observed the drop in sales and rise in listings, characterizing Toronto as essentially a “buyers’ market.” However, Asher also highlights a concerning trend: the increase in listing cancellations. This implies that while the number of listings is growing, sellers are withdrawing their properties from the market out of frustration.
Investment properties are more vulnerable in a high interest rate environment since higher mortgage payments mean higher ownership costs. When the average market rents for condominiums are not high enough to cover those costs, investing in condos becomes less attractive. Hence, April condominium sales in Toronto have been the lowest since 2017, except for 2020 when pandemic-mandated restrictions partially shut down the markets.
While the cherry blossoms will bloom again next year, the housing market need not wait as long for a revival. With favourable interest rate policies and a timely reduction in mortgage rates, we could see a boost in sales later this summer. The crucial question remains: Will the anticipated rate cuts provide the needed spark for the housing market, or will other economic factors dampen the recovery? The future of Canada’s housing market hangs in the balance.
OSFI Says Mortgage Payment Shock Poses a Key Risk to Canada’s Financial System
Canada’s banking regulator, the Office of the Superintendent of Financial Institutions (OSFI), has issued a stark warning about the potential for mortgage payment shock to pose a significant risk to the country’s financial system. With high borrowing costs and a wave of expected mortgage renewals over the next 18 months, homeowners and financial institutions alike face uncertain times.
According to OSFI, 76% of outstanding mortgages in Canada are expected to come up for renewal by the end of 2026. This impending renewal wave is particularly concerning for those who secured mortgages between 2020 and 2022 when interest rates were at historic lows. As these borrowers face renewal at much higher rates, the financial strain could be substantial.
Households with high leverage and variable-rate mortgages with fixed payments are expected to feel the impact most acutely. OSFI’s Annual Risk Outlook for 2024-25 indicates that these households will likely experience significant payment increases, which could lead to a higher incidence of mortgage arrears or defaults. This situation could result in greater credit losses for financial institutions, especially if the residential real estate market weakens.
Adjustable-rate mortgages, which have already seen payment increases, are showing higher default rates. This trend underscores the vulnerabilities within the mortgage market and highlights the potential for broader financial instability. In response to these risks, OSFI has implemented loan-to-income limits for lenders’ uninsured mortgage portfolios to prevent a buildup of highly leveraged borrowers.
In March, OSFI confirmed that federally regulated banks must limit the number of mortgages exceeding 4.5 times the borrower’s annual income. This measure aims to mitigate the risks associated with high debt levels among borrowers. Although these limits are currently not expected to be binding, they represent a proactive approach to managing financial risk.
Additionally, OSFI has maintained the minimum qualifying rate for uninsured mortgages at the greater of the mortgage contract rate plus 2% or 5.25%. This policy is designed to ensure that borrowers can continue to make payments even if they encounter negative financial shocks.
One specific area of concern for OSFI is fixed-payment variable-rate mortgages. These products, which keep monthly payments constant despite fluctuating interest rates, can lead to situations where a larger portion of payments goes towards interest rather than principal. As interest rates have risen over the past two years, this has become a significant issue, particularly as these mortgages currently account for about 15% of outstanding residential mortgages in Canada.
OSFI has previously voiced concerns about these mortgages. Last fall, OSFI head Peter Routledge described them as a “dangerous product” that increases the risk of default for certain borrowers. While OSFI does not impose judgments on product design, it believes the financial system would be healthier with fewer of these products in circulation.
OSFI’s Annual Risk Outlook also highlights other risks facing Canada’s financial system, including wholesale credit risk and funding and liquidity risks. Wholesale credit risk, which encompasses commercial real estate lending and corporate debt, remains a significant exposure for financial institutions. Higher interest rates, inflation, and reduced demand have put pressure on commercial real estate markets, and these challenges are expected to persist into 2024 and 2025.
Liquidity risks, which can arise if depositor behavior shifts dramatically, are another persistent concern. Deteriorating credit conditions can negatively impact securitization markets, increasing liquidity risk for institutions that rely on securitization as a key funding source. To address these risks, OSFI plans to intensify its assessment of liquidity risk.
Amid these concerns, Canadian banks are preparing to report their second-quarter results. The economic steadiness of the recent quarter contrasts sharply with the turbulence seen a year earlier, marked by bank failures in the U.S. and Switzerland. Encouraging economic data, such as a decline in inflation to 2.7% in April, has boosted market expectations for a potential rate cut in June. However, with the timing and pace of rate cuts still uncertain, analysts are focused on how well bank loans will hold up.
Credit quality remains a top concern for investors. RBC analyst Darko Mihelic notes that signs of credit deterioration are emerging, with mortgage renewal shocks continuing to be a significant issue. The Bank of Canada has reported that some borrowers face renewals that could lead to a more than 60% jump in payments, though so far, homeowners appear to be managing well.
Despite the relatively low levels of mortgage delinquencies, strain is increasing on borrowers, particularly those with smaller banks that cater to higher-risk borrowers. Residential mortgages more than 90 days past due are higher at small banks compared to large banks, indicating growing financial pressure.
As banks manage these challenges, analysts are also interested in their outlook for profit margins and credit conditions. Canaccord Genuity analyst Matthew Lee expects a cautious view from banks, given the more daunting economic landscape consumers face.
The broader question remains: Is the Canadian economic miracle over? With issues such as plunging productivity, unsustainable fiscal policy, and one of the world’s most expensive housing markets, the long-term health of the Canadian economy is in question. The answer to this question will shape the future trajectory of both the economy and the banking sector. How will Canada navigate these challenges, and what steps will be necessary to ensure stability and growth in the coming years?