Understanding the Benchmark

A Benchmark Interest Rate, sometimes called a reference rate or overnight rate, is upon which other central banks’ interest rates are determined. It is the minimum rate investors will require for investing.

Here’s how it works in practice from ecb.europa.eu: A bank may agree to lend money to an organization at an agreed interest rate, say the benchmark rate plus 2% – meaning that the organization would pay interest of 2% more than the current benchmark rate. So, the cost of borrowing money goes up if the benchmark rate goes up, and the cost of the loan goes down if the benchmark rate drops. In this case, the benchmark can be a reliable, independent, and relatively simple reference for all involved.

Benchmark rates are used in more complicated financial transactions as well, such as the issuance of securities with variable rates, options, forward contracts, and swaps.

Bank of Canada’s 2022 Scorecard So Far…

In April of this year, the Bank of Canada increased the overnight rate by half a percentage point each. In June, we saw a half a percentage point increase again. On July 13th, the Bank of Canada increased its overnight rate to 2.5%.

On Sept 6th, the Bank of Canada increased the overnight rate again to 3.25%and a bank rate of 3.50% again to combat rising inflation.

Bank of Canada: What the Future Holds

On the Bank of Canada’s website, it lists its policy interest rate decision announcement dates. In the short-term, we can anticipate potential interest rate hikes on some of the following dates:

• Wednesday, January 25
• Wednesday, March 8
• Wednesday, April 12
• Wednesday, June 7
• Wednesday, July 12
• Wednesday, September 6
• Wednesday, October 25
• Wednesday, December 6

The Bank of Canada also reconfirmed the scheduled rate announcement dates for the remainder of 2022:

• Wednesday, October 26
• Wednesday, December 7

It All Started With Supply Chain

It’s common knowledge that the cost of virtually everything has increased due to COVID-19. It’s a trickle effect that started with supply chain constraints which in turn drove up the costs of goods.

Business owners had challenges finding the standard-issued products needed to provide their services to consumers, or when they did find those items, they had to pay a premium for them. This increased the business owner’s overhead and as a result, the cost to the consumer is greater, as well.

Canadian Consumer Price Index

According to Statistics Canada, “The Consumer Price Index (CPI) represents changes in prices as experienced by Canadian consumers. It measures price change by comparing, through time, the cost of a fixed basket of goods and services.”

Over the last few months, inflation has been increasingly putting pressure on Canadian households as the Canadian Consumer Price Index reports decades-high figures.

Bank of Canada Feels like a Variable Rate

A lot is on the line when the Bank of Canada is raising rates, including rising mortgage rates (fixed rates and variable rates may be affected long-term) and the possibility of a recession, so it makes sense that so many are watching to see where things go.

With the most recent increase, many homeowners are wondering just how high interest rates will continue to go. For anyone who has a mortgage, be it a fixed rate mortgage or variable rate, the fluctuation of interest rates might affect you for the next decade or more.

It only stands to reason then, that some may want the peace of mind of knowing whether we’ll be facing upward pressure on housing affordability and inflation expectations.

We can’t tell you with absolute certainty where the federal government will take interest rates will go in the next few months, let alone the next number of years.

Can versus Can’t

What we can do is help to give you a peek behind the curtain on monetary policy tools to assess economic conditions to determine whether or not to raise rates. We can also share some expert opinions expressed on where the Canadian rate may go in the future.

Why Do Interest Rates Change?

To begin with, you might need a bit of a refresher on the purpose of the Bank of Canada’s interest rates and why they change over time.

The Role of the Central Bank

Essentially, the role of the central bank ( in our case, the Bank of Canada) is the primary source of Canadian dollars entering the economy as well as the primary director of monetary policy in the country. Their mandate is simple: to control inflation at an acceptable rate of around one to three percent.

Bank of Canada and the Big Banks

The Bank of Canada raised the cost of borrowing money for big banks through a rate hike that the bank charges to borrowers. The banks then pass these costs on to Canadians. The higher interest rates are intended to control how much Canadians are willing to spend their money.

When borrowing and debt is at a record low, people tend to spend more, and inflation increases in response to increased demand. When we see interest rates go up, people tend to prefer saving their money and limiting debt, whether it be in the form of fixed mortgage rates or variable mortgage rates, which reduces demand and encourages companies to keep prices low.

If this rise goes further than expected, it may push companies to take aggressive action to combat the rate hike such reduce their spending with job cuts, which could push us into recession territory.

Risk of Recession

Notably, though, the Bank as a governing council is only concerned with maintaining a healthy rate of inflation and has no mandate to avoid a recession. If risking a recession now is in the best interest of the Canadian economy long term, the bank will, unfortunately, pursue this option.

The Bank of Canada’s Bottom Line

So the bottom line is this: the Bank of Canada’s interest rate is the single tool that is capable of influencing inflation at the highest level in Canada. In order to keep inflation within the target range, the bank will raise or lower interest rates accordingly.

Other things that influence interest rates beyond inflation may include supply and demand factors, government debts and a budget deficit, global commodity market conditions, and our commodity prices, the national labour market with wage growth, a rise or fall in home prices and more.

How Can We Predict Interest Rates?

In the short term, we can generally predict the course of the economy in broad strokes. In fact, the Bank of Canada uses these predictions themselves to decide how interest rates need to change. For example, if the Canadian economy starts off in the first half of the fiscal year in a way that is expected, this may signal to the central bank whether a course correction is needed for the second half of the year. When we look at a longer time period, however, it becomes increasingly hard to predict.

Even if there’s a five-year government plan that promises excellent efficacy to thwart a rise in inflation, we live in an increasingly connected modern world. Inflation is often a symptom of global causes and upon which we have little control.

This is most clearly demonstrated in our recent worldwide COVID-19 pandemic. The pandemic had a huge impact on global markets, including globally high home prices, which saw a rise in inflation.

While economists in the past have theorized the impacts of a global pandemic, there has been no real way to predict when it might happen and thus adequately prepare.

Factors that May Influence Rates in the Future

There are a number of national and international factors that can influence the trajectory of a nation’s average rate of interest, including the Bank of Canada rate.

Some short-term interest rate impactors that we’re already privy to internationally are in the form of the pandemic, decreased fuel costs by the Organization of Petroleum Exporting Countries (OPEC) and the Russian invasion of Ukraine. We can see the impact of each of these international factors in the near term, or in short order; they have caused large-scale interruptions of global markets that affect the way money moves and the way people spend.

The possibility of international conflicts is always present, and will no doubt have effects on our economy. Another factor that is sure to be an issue in the coming decades will be the cost of the effects of climate change, which will result in increased costs of necessities like food and energy.

Nationally, the number of people who received preapproval for a variable rate or fixed mortgage rate grew. With that increase in real estate closing costs, will we now see that we, as a country, are over-leverage?

It is the answer to this question that is causing some folks to speculate on the threat of a real estate market crash in the front and/or a global recession in the second half.

Interest Rate Predictions from the Experts

What does the future hold for Canada’s economy in terms of mortgage rates forecast, and housing prices?

What CIBC Says

Benjamin Tal and Karyne Charbonneau each of whom are chief economists for CIBC, note that given the September rate increase, they expect the Bank of Canada will call it a day, leaving the overnight target rate at 3.25% “for the duration of 2023.”

While CIBC doesn’t see any further rate hikes in 2023, in examining the economic factors, it also doesn’t expect the Bank of Canada to begin easing rates any sooner than 2024.

According to Altrua Financial

Altruafinancial.ca believes that the main tool we have when reading the current mortgage rate market is the Government of Canada bond market yield.

Currently, the Canadian bond markets are priced in anticipation of a further 0.75% increase in Central Bank of Canada rates in 2022- early 2023 or perhaps even slightly higher.

TD Economists Predict

In its short to medium-term Canadian interest rate predictions, TD Economics projected the Bank of Canada to increase rates in the fourth quarter and maintain the level until the end of 2023.    TD Economics predicted the Canadian central bank to lower the policy rate to 2.90% in 2024, 2.05% in 2025, 2% in 2026 and 2% in 2027.

Scotiabank indicates

Scotiabank expects the Bank of Canada to raise its overnight rate to 3.5% in the fourth quarter of 2022 and maintain the rate throughout 2023.

ING forecasts

ING’s forecast expects the Bank of Canada to have a further 75 base points of hikes, bringing the overnight rate to 4% in the fourth quarter of 2022, dropping to 3.75% in the third quarter and 3.25% in the fourth quarter of 2023 respectively.

What Will the Next 10 Years Look Like?

According to the CBC’s article, Typical mortgage payment could be 30% higher in 5 years, Bank of Canada warns “Bank says those who took out a home loan in 2020 or 2021 should brace for higher rates at renewal.”

In its Financial System Review, the Bank of Canada said that while the nation’s financial system is strong and weathered the pandemic well, the economy remains vulnerable because of higher household debt levels tied to the country’s increasingly expensive house prices.

Looking south of the border—which typically influences rates on this side of the border—Federal Reserve Chair Jerome Powell spoke to a quantitative tightening, “Restoring price stability will likely require maintaining a restrictive policy stance for some time…The historical record cautions strongly against prematurely loosening policy… must keep at it until the job is done in order to avoid a scenario like the multiple failed attempts to lower inflation [in the 1970s].”

It’s Safe to Say

It’s safe to say that both north and south of the border, we can expect those that hold the national balance sheets to be fiscally conservative. Whether that translates to increasingly rising rates, the experts seem divided on that. However, two things that are clear as day are that (1) no one is ready to rule out the possibility of a recession, and (2) everyone advocates a fiscally responsible approach to taking whatever steps are necessary to avoid a full-blown depression.