Yesterday, the Bank of Canada has cut its benchmark interest rate from 5% to 4.75%, marking its first rate reduction in four years. This 25 basis point cut comes as a response to a slowing Canadian economy, particularly in Central Canada. This move has significant implications for borrowing costs, the real estate market, and future economic policies.
While a 25 basis point cut might seem minor, it signals a potential shift towards an easing cycle after a period of aggressive rate hikes aimed at curbing inflation. Over the past two years, the Bank of Canada raised the rate from 0.25% to 5% in the fastest increase in the nation’s history to rein in inflation by suppressing demand. With inflation now more controlled, this rate cut may pave the way for further reductions, potentially making borrowing cheaper and stimulating economic growth.
The immediate effects of this rate cut on mortgage payments, car loans, and lines of credit will be minimal. For borrowers, the reduction will result in savings of less or more than $100-$200 per month. For instance, for a 25-year mortgage term, the initial monthly payment with a 7% interest rate for a $350,000 mortgage amounts to approximately $2,400. With the interest rate reduced to 6%, the new monthly payment would be around $2,200. Therefore, the savings resulting from this rate cut would be approximately $200 per month. While this reduction provides some relief to borrowers, it may not significantly alter the financial situation for most individuals.
Canada is the first G7 country to lower interest rates in this current economic climate. This move may set a precedent, potentially influencing other major economies facing similar conditions. With the European Central Bank’s decision pending, Canada’s action could serve as a benchmark for global economic policy shifts.
Lower interest rates typically benefit the real estate market by making mortgages more affordable, potentially boosting housing demand. However, this effect is not immediate. The current high prices and underperforming sector need more than just a slight rate cut to see significant changes. While this reduction might encourage some new buyers, it also carries the risk of reigniting excessive demand, pushing housing prices further up. A balanced approach is necessary to avoid overheating the market.
Bank of Canada Governor Tiff Macklem emphasized a cautious approach to further rate cuts, noting the balance needed between stimulating economic growth and preventing a resurgence of inflation. The decision-making will be data-driven, considering factors like geopolitical turmoil and domestic economic conditions. While more cuts are anticipated, each will be carefully considered to avoid destabilizing the progress made in controlling inflation.
Canada’s Big Six banks are preparing for potential increases in loan delinquencies as a significant portion of mortgages come up for renewal. They have collectively set aside $4.3 billion in the latest quarter to cover bad loans, almost double the amount from the same quarter last year. This precaution is driven by the expectation that many homeowners will face higher mortgage payments upon renewal due to the elevated interest rates.
More than three-quarters of Canadian mortgages are up for renewal between now and the end of 2026. Many homeowners who secured mortgages at historically low rates during 2020-2021 will now face significantly higher payments. For example, a couple who bought an average-priced house in 2019 with a $500,000 mortgage at 2.9% would see their monthly payments increase by approximately $700 if they renew at current rates around 6%.
Variable rate mortgage holders with fixed monthly payments are particularly vulnerable. While their payments haven’t increased with rising rates, the principal portion of their payments has been shrinking, extending their mortgage terms and increasing their overall interest costs. These homeowners may soon face a substantial increase in their monthly payments when their mortgages are recalculated, posing a risk of higher delinquencies.
As Canada’s major banks prepare for increased mortgage delinquencies, the effects of this rate cut will unfold in the coming months, offering both challenges and opportunities for the Canadian economy. The cautious approach to further rate cuts suggests a measured path forward, balancing growth stimulation with inflation control.