Last year, the Bank of Canada and central banks globally were committed to the idea that inflation was transitory and once supply chain issues were resolved prices would return to normal. In Canada this was especially strange given the Bank of Canada only mandate was to keep inflation between 1-3%, inflation was well above 3% and house prices were increasing nationally at close to 30% year over year.

Thankfully, the BoC’s mandate has been expanded to include inclusion, diversity, and the environment, to provide some achievable targets as it seems clear that the BoC remains lost on inflation.

After today’s rate hike (0.75%) the overnight rate and the yield on a 5-year government of Canada bond are both 3.25%, which implies the market is anticipating additional rate hikes will not be needed to cool inflation. Looking more closely at the yield curve, the bond market is indicating that there may be another small rate hike that could be quickly unwound.

With house prices and gas prices already down 30% from their peaks (and falling), it seems obvious that inflation will be less of an issue going forward. Higher debt levels in the economy, and a higher proportion of debt being variable rate will cause the rate hikes we have seen to date continue to negatively impact the economy over the next 12-18 months.

With perfect hindsight, instead of locking into a fixed rate mortgage, most borrowers would have been better off selling their house instead of renewing their mortgage(s). House prices will continue to be under pressure with the stress test reducing borrowing power by 15% since the Bank of Canada’s July rate hike, many borrowers unable to service higher payments on renewal, but more importantly many borrowers who secured short term equity-based loans will need to sell their houses when these mortgages come up for renewal (typically 1-year loans) as market values no longer support these equity based mortgages.

Market watchers are into the absurd situation of trying to predict the magnitude of additional policy mistakes from the Bank of Canada. At this point the market is indicating that any further rate hikes will be undone despite the Bank of Canada’s belief that interest rates will need to rise further.

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