The Bank of Canada’s first interest rate cut in over four years on Wednesday will have a “psychological” impact on the Canadian housing market, but will likely not be enough to meaningfully improve affordability, experts say.
The Bank of Canada cut its key policy rate, which informs the rates Canadians pay on loans like mortgages, by 25 basis points to 4.75 per cent.
“Canadians have not had a rate cut from our central bank since the early days of the pandemic,” says James Laird, co-CEO of Ratehub.ca. “This is a huge move that we are now into a declining rate environment.”
Impact on variable, fixed mortgage rates
In general, the higher the Bank of Canada’s benchmark rate sits, the more Canadians who are taking out or renewing mortgages will pay on a monthly basis. Lenders in Canada base the rates they are offering on many mortgages and other loans on their prime rates, which move in concert with the central bank’s rate.
All of the big six Canadian banks cut their prime rates by a quarter-percentage point in the wake of the Bank of Canada’s rate cut on Wednesday.
Higher interest rates also affect how much Canadians can qualify for a mortgage when they’re looking to buy a home, making this a key barrier to housing affordability.
Laird says that for prospective buyers who have been sidelined by higher interest rates over the past two years, the impact of a single 25-basis-point rate cut will be “marginal” but not a “dramatic help.”
“If you were nowhere close to qualifying for a home, you’re not going to qualify still,” he says, noting that some qualified buyers might be able to afford a little bit more than they would have previously.
Homeowners with variable-rate mortgages are expected to see the most immediate relief from the Bank of Canada’s rate cut. Those with static payments on their mortgages will see more of their monthly payments go towards principal rather than interest, while those with floating payments will pay less accordingly.
Ratehub’s analysis shows the representative variable mortgage holder would see their monthly payments drop by nearly $100 per month after the cut, with Laird noting that homeowners with bigger outstanding mortgage balances will see the largest relative relief.
ATB Financial chief economist Mark Parsons says the reality is a bit different for those with a fixed-rate mortgage, which see rates change at renewal when their terms end.
“If you’re on a variable-rate mortgage you’re going to see an impact relatively soon; if you’re on a fixed, it might take a little bit more time,” Parsons says.
Fixed-rate mortgages are indirectly tied to the Bank of Canada’s policy rate through the bond market. The rate on the popular five-year fixed mortgage, for instance, is tied to the five-year government of Canada (GoC) bond yield. Prices here are set on expectations for where the central bank’s key rate is heading over the next five years.
Wednesday’s rate cut was already priced into bond markets, Parsons notes, so the decision won’t have an immediate impact. The five-year GoC bond yield has dipped significantly since the start of June, however, down nearly 40 basis points. Lenders tend to be slower to transfer falling bond yields into their mortgage rates on offer than they are on the uptick, however.
Banks weren’t going to change their rates ahead of the central bank’s decision, Laird says, but now that it’s set in stone, consumers can expect fixed rates to move lower in the months ahead.
Anyone debating between a fixed or variable mortgage today will have to weigh whether the central bank is going to cut its benchmark rate quickly and substantially enough to make the risk of taking a higher variable-rate mortgage today worth the trade-off of locking into a lower fixed.
Laird says the Bank of Canada would need to cut by about 200 basis points within the next two years for the math to work out here for the typical homeowner.
Will a rate cut reignite sleepy housing markets?
Borrowing costs aside, the Bank of Canada’s long-anticipated shift away from interest rate cuts and holds and into an easing cycle is a “positive for would-be buyers” in Canada’s housing markets, Parsons notes.
That’s not because buyers can expect a “big cut” in their mortgage rates tomorrow, he explains. Parsons says the first cut gives buyers clarity that the future direction for rates is more likely down than up – something they didn’t have a year ago, when rate hikes were making their return after a brief pause in the cycle.
“When rates are going up, you don’t know how long it’s going to last. That’s not a very good environment for homebuyers,” he says. “The rate cut provides them certainty and confidence they didn’t have before.”
The rate cut comes as housing markets across Canada have sleepwalked through the historically busy spring season. The Canadian Real Estate Association says a flood of sellers hitting the market this spring has been so far met by few buyers, slowing overall sales activity.
Davelle Morrison, a real estate broker in the North York district of Toronto, says it’s been a “challenging” time period for the market.
“I like to say that maybe the markets decided to take a bit of a break,” she says of the spring.
News of the interest rate cut will usher a “sense of relief” into the market, Morrison says.
While she does not believe a quarter-percentage-point rate cut itself will spur a flood of new buyers, she argues the shift in monetary policy and suggestions from Bank of Canada officials that further drops are in the cards could have a “psychological” impact on buyers.
Hopes for additional interest rate cuts this year will bring more buyers off the sidelines, Morrison believes.
“I would imagine there could be some people who go, ‘You know what, I feel comfortable purchasing a place now and maybe closing in August or the end of July,’ where they think there’s going to be another rate cut,” she says.
A report from Royal LePage in February showed more than half (56 per cent) of would-be homebuyers polled had put their search on pause amid the Bank of Canada rate hike cycle.
Of those sidelined buyers, one in 10 said it would take just one quarter-percentage rate drop to get them back in the market. Nearly one in five (18 per cent) said they’d resume the search with 50-100 basis points of cuts, while 23 per cent said they needed to see even steeper drops.
Will home prices rise after rate cut?
Economists are divided on where the central bank heads next, with some predicting back-to-back rate cuts and others suggesting the central bank will pause before proceeding with more easing.
Bank of Canada governor Tiff Macklem said Wednesday that the next decision will depend on the economic data the central bank receives before its upcoming meeting on July 24.
Laird also used the word “psychological” to describe the rate cut’s impact on the housing market.
He says he’s curious whether an initial interest rate cut will be enough to spur FOMO, or a fear of missing out, among buyers. When borrowing costs drop and more buyers enter the market, competition tends to drive up prices.
Laird is watching to see whether buyers leap at the first sign of rate cuts to buy a home they think would be more expensive in a few months, or if the reality of still-high interest rates will keep would-be buyers patient in the near term.
That’s a phenomenon the Bank of Canada has also signalled it’s watching closely.
The Bank of Canada’s latest economic forecasts do anticipate an increase in home prices this year. But the central bank on Wednesday flagged home values rising faster than it anticipates as one outstanding risk to inflation going forward.
Bank of Canada senior deputy governor Carolyn Rogers was asked Wednesday about how the central bank balances the risks of accelerating shelter inflation with its rate cut, but she said that monetary policymakers are not targeting housing activity in particular with the policy rate.
“Ultimately, what we target is inflation,” Rogers said. “We don’t target any particular measure in the housing market or an interest rate, but it’s clear there is some pent-up demand in the housing market. We’ll see how it goes.”
– with files from Global News’s Anne Gaviola, Erik Bay