The Bank delivered an expected 50-basis-point hike to its benchmark rate. Within hours, the Big 5 banks announced a similar increase to their prime rates, which are the basis for pricing variable-rate mortgages.

Variable mortgage rates are about to rise following the Bank of Canada’s latest interest rate hike last week.

That brings the prime rate at most lenders to 3.20%, with a notable exception being TD Bank, which prices its mortgage prime rate 15 bps higher, at 3.35%.

In its statement following Wednesday’s rate decision, the Bank of Canada said, “With the economy moving into excess demand and inflation persisting well above target, the Governing Council judges that interest rates will need to rise further.”

The Bank raised its projected neutral rate by 25 bps to a range of 2-3%, or a target rate of 2.5%. With its overnight rate now at 1.00%, that implies rates may need to climb another 100 basis points or more to bring inflation back under control.

Such an increase would further close the spread between fixed and variable rates, which continues to sit at around 150 basis points. Following a surge in bond yields, fixed mortgage rates have risen steadily over the past few months, bringing them to around the 4% mark.

So, even if the Bank of Canada hikes another 100 basis points, average variable rates would still be about 50 bps lower than current comparable fixed rates.

Inflation a growing concern

With inflation now at a 30-year high, the Bank of Canada says it will likely rise higher this year–driven by
ongoing supply disruptions and commodity price increases–before starting to ease next year.

In its upwardly revised forecast, the BoC expects headline inflation to average 6% for the first half of 2022 before easing to 2.5% in the second half of 2023. The Bank then expects inflation to ease further to its 2% target by the end of 2024.

“There is an increasing risk that expectations of elevated inflation could become entrenched,” the BoC said in its statement. “The Bank will use its monetary policy tools to return inflation to target and keep inflation expectations well-anchored.

Reaction and forecasts

Given the Bank’s clear concerns about elevated inflation and its hawkish statement delivered on Wednesday, market expectations are for another half-point rate hike at the Bank’s next policy meeting in June.

“As for the near-term outlook, the bar for a second consecutive 50 basis point hike isn’t particularly high in our view,” economists from National Bank of Canada wrote. “Should April labour market data show continued tightening and if the March/April CPI reports don’t show signs of easing, 50 bps should be viewed as the most likely outcome in seven weeks.”

Douglas Porter, chief economist at BMO, agrees, saying their forecast now expects not only a 50-bps hike in June, but a second half-point increase in July. That, he says, would be followed by a final quarter-point hike before the end of the year, bringing the overnight target rate to 2.25%

“The task at hand is clear to all, and the need for speed is obvious,” he wrote.

But just how long the Bank of Canada’s benchmark rate remains elevated is still a big questions mark, with some suggesting variable rates could actually start to decline part-way through a five-year term.

“Anyone starting a 5-year variable-rate term today is no doubt focusing on how much higher their rate will go over the near term,” mortgage broker Dave Larock noted in a recent blog post.

“But they should also remember that the bond market continues to price in BoC rate cuts in 2024 under the assumption that the Bank will end up over-tightening and will have to reverse course when the economy slows by more than expected,” he added. “If that ends up happening, anyone starting a variable-rate mortgage today will be only about halfway through their term at that point.”

Anyone unsure whether a fixed or variable rate makes the most sense for their personal situation and risk tolerance should first talk to a mortgage broker to discuss strategies and the options that are available.