Record Home Price Growth Continued in December

The Canadian Real Estate Association’s House Price Index was up 26% year-over-year as of December, the fastest pace on record.

Analysts say the ongoing price increases are being driven by falling inventory levels and increased demand as buyers try to make their purchases ahead of expected interest rate hikes from the Bank of Canada.

The number of months of inventory fell to a fresh record low of 1.6 months, well below the longer-term average of five months.

The average selling price in December was $713,500, up 17.7% year-over-year on an unadjusted basis, according to the CREA’s latest monthly report. Home sales ticked up in the month, rising 0.2% to 54,366. On an annual basis, home sales totalled 666,995, setting a new record and surpassing the previous high set in 2020 by more than 20%.

“With the housing supply issues facing the country having only gotten worse to start 2022, take any decline in sales early in the year with a grain of salt because the demand hasn’t gone away, there just won’t be much to buy until a little later in this spring,” said CREA chair Cliff Stevenson. “But when those listings eventually start to show up, the spring market this year will almost certainly be another headline grabber.”

Removing the high-priced markets of the Greater Toronto and Vancouver areas, the average price stands at $563,500.

Cross-Country Roundup of Home Prices

In just the past three months, average prices have risen by $125,600 in the Greater Toronto Area, $44,100 in the Greater Vancouver Area, $18,100 in Greater Montreal and $21,600 in Ottawa.

Here’s a look at some more regional and local housing market results for December:

• Ontario: $922,735 (+22.8%)
• Quebec: $473,032 (+17.9)
• B.C.: $1,031,067 (+22.5%)
• Alberta: $420,842 (+7.4%)
• Barrie & District: $836,200 (+38.8%)
• Greater Toronto Area: $1,208,000 (+31.1%)
• Victoria: $902,700 (+23.6%)
• Halifax-Dartmouth: $490,127 (+22.2%)
• Greater Montreal Area: $517,800 (+21.3%)
• Greater Vancouver Area: $1,230,200 (+17.3%)
• Ottawa: $661,500 (+16.1%)
• Winnipeg: $319,600 (+11.7%)
• Calgary: $451,200 (+9.7%)
• St. John’s: $292,000 (+9.3%)
• Edmonton: $336,600 (+4.1%)

Price pressures could persist throughout the year

As has been the case for several months already, future demand is being pulled forward as buyers try to make their purchases ahead of looming interest rate hikes.

“With interest-rate pull-forward behaviour keeping demand so strong, and supply struggling to keep up, it’s little wonder why prices are continuing their relentless upward march,” noted TD economist Rishi Sondhi. “However, while prices will likely increase this year, higher interest rates should slow the rate of increase. Notably, investor activity is climbing and these buyers are likely more sensitive to higher rates.”

Robert Kavcic, senior economist with BMO Economics, said interest rates have been left too low for too long, which has now resulted in the market becoming “unhinged.”

“Very early last year, BMO Economics warned that policy (starting on the monetary side) needed to tighten in order to prevent the market from becoming dislodged from underlying fundamentals…Now, it appears that 2021 was the year the market became unhinged,” he wrote. “Expectations and investor appetite took over Canadian housing in 2021. We know it, and policymakers now know it too. Look for 100 bps of tightening by the Bank of Canada this year to help clean out some of the froth.”

Even without the extra short-term demand, observers say a chronic shortage of housing supply will continue to keep upward pressure on prices until policymakers get serious about addressing the issue.

“There are currently fewer properties listed for sale in Canada than at any point on record. So, unfortunately, the housing affordability problem facing the country is likely to get worse before it gets better,” said CREA’s chief economist Shaun Cathcart.

“Policymakers are starting to say the right things, but now they have to act to change this course we’re on,” he continued. “An aggressive national push to build more homes is what will address the issue, but it will probably have to be a greater amount of building than anything we’ve ever undertaken. A touch over the status quo won’t cut it.”

The Latest in Mortgage News: CMHC to Review Investment Property Down Payments

It’s no secret that the federal government is eyeing reforms to investment properties in an effort to help reel in runaway house prices.

In a mandate letter sent from the Prime Minister in December, Housing Minister Ahmed Hussen was specifically directed to “review the down payment requirements for investment properties” and develop policies to “curb excessive profits” in that housing segment.

In 2021, over a quarter of all home purchases were made by buyers who already own a home—investors in many cases—according to data from Teranet.

“…our government is looking at every tool at our disposal to tackle these challenges head on,” the Ministry of Housing and Diversity and Inclusion and Canada Mortgage and Housing Corporation (CMHC) told the Financial Post in a statement. “By developing policies to curb excessive profits in investment properties, protecting small independent landlords and Canadian families, and reviewing the down payment requirements for investment properties, we are targeting the issues the market is facing from multiple angles.”

The government has not yet released details on potential changes to investment property down payment rules that are being considered, nor has it provided a timeline for any announcements.

Currently, non-owner-occupied rental properties in Canada with up to four units require a down payment of at least 20% by most lenders.

Mortgage expert Rob McLister told the Financial Post on Wednesday that a five percentage-point-increase to the minimum down payment would likely slow investment purchases “incrementally,” while implementing a 35% minimum down payment would “substantially slow” such purchases.

He added that regulators could also introduce restrictions on the use of borrowed money, such as home equity lines of credit, to fund down payments.

(Updated)

Jason Ellis Appointed CEO of First National

After serving in various roles at First National for nearly 18 years, Jason Ellis has been named the company’s new Chief Executive Officer effective today.

Ellis, who first joined the company in 2004, served as Chief Operating Officer since 2018 and in 2019 added the title of President.

Outgoing CEO Stephen Smith, who served in the role since First National went public in 2006, will continue to provide strategic advice and guidance to management in a newly created role of Executive Chairman.

Smith founded First National in 1988 with Moray Tawse, growing the company to one of Canada’s largest non-bank originators and underwriters of mortgages with $121 billion in mortgages under administration.

“Jason is uniquely qualified to lead First National as my natural successor,” Smith said in a statement. “Passing the baton to Jason is something that I am pleased to do as I know he will take First National to the next level of achievement for the benefit of our employees, customers, partners and shareholders.”

B.C. Saw Record Sales in 2021

More than 124,800 residential units traded hands in British Columbia in 2021, according to final 2021 figures released from the B.C. Real Estate Association (BCREA).

That’s a 33% increase from 2020. Meanwhile, the average MLS residential price in the province was $927,877, a nearly 19% jump from the year before. In three of B.C.’s largest markets, the average price of a home is now over $1 million.

“Last year was a record year for BC homes sales with seven market areas setting new highs,” BCREA Chief Economist Brendon Ogmundson said in a release. “Listings activity could not keep up with demand throughout the year. As a result, we start 2022 with the lowest level of active listings on record.”

Total active listings are currently at a record low of just 12,179 units, down over 41% from 2020.

–Steve Huebl

The Latest in Mortgage News: CMHC to Review Investment Property Down Payments

It’s no secret that the federal government is eyeing reforms to investment properties in an effort to help reel in runaway house prices.

In a mandate letter sent from the Prime Minister in December, Housing Minister Ahmed Hussen was specifically directed to “review the down payment requirements for investment properties” and develop policies to “curb excessive profits” in that housing segment.

In 2021, over a quarter of all home purchases were made by buyers who already own a home—investors in many cases—according to data from Teranet.

“…our government is looking at every tool at our disposal to tackle these challenges head on,” the Ministry of Housing and Diversity and Inclusion and Canada Mortgage and Housing Corporation (CMHC) told the Financial Post in a statement. “By developing policies to curb excessive profits in investment properties, protecting small independent landlords and Canadian families, and reviewing the down payment requirements for investment properties, we are targeting the issues the market is facing from multiple angles.”

The government has not yet released details on potential changes to investment property down payment rules that are being considered, nor has it provided a timeline for any announcements.

Currently, non-owner-occupied rental properties in Canada with up to four units require a down payment of at least 20% by most lenders.

Mortgage expert Rob McLister told the Financial Post on Wednesday that a five percentage-point-increase to the minimum down payment would likely slow investment purchases “incrementally,” while implementing a 35% minimum down payment would “substantially slow” such purchases.

He added that regulators could also introduce restrictions on the use of borrowed money, such as home equity lines of credit, to fund down payments.

(Updated)

Jason Ellis Appointed CEO of First National

After serving in various roles at First National for nearly 18 years, Jason Ellis has been named the company’s new Chief Executive Officer effective today.

Ellis, who first joined the company in 2004, served as Chief Operating Officer since 2018 and in 2019 added the title of President.

Outgoing CEO Stephen Smith, who served in the role since First National went public in 2006, will continue to provide strategic advice and guidance to management in a newly created role of Executive Chairman.

Smith founded First National in 1988 with Moray Tawse, growing the company to one of Canada’s largest non-bank originators and underwriters of mortgages with $121 billion in mortgages under administration.

“Jason is uniquely qualified to lead First National as my natural successor,” Smith said in a statement. “Passing the baton to Jason is something that I am pleased to do as I know he will take First National to the next level of achievement for the benefit of our employees, customers, partners and shareholders.”

B.C. Saw Record Sales in 2021

More than 124,800 residential units traded hands in British Columbia in 2021, according to final 2021 figures released from the B.C. Real Estate Association (BCREA).

That’s a 33% increase from 2020. Meanwhile, the average MLS residential price in the province was $927,877, a nearly 19% jump from the year before. In three of B.C.’s largest markets, the average price of a home is now over $1 million.

“Last year was a record year for BC homes sales with seven market areas setting new highs,” BCREA Chief Economist Brendon Ogmundson said in a release. “Listings activity could not keep up with demand throughout the year. As a result, we start 2022 with the lowest level of active listings on record.”

Total active listings are currently at a record low of just 12,179 units, down over 41% from 2020.

–Steve Huebl

Can You Qualify for a Mortgage While on Probation at Your Job?

Last year, we noticed an increase in the number of mortgage applicants who are still on probation at their jobs.

In the past, we tended to advise these clients to wait until their probation was completed, because lenders view them as a higher risk of not making their mortgage payments (if released during probation). But in some cases, that may not be necessary.

We recently discussed this topic on a mortgage industry Facebook discussion board and received some feedback from seasoned experts on which circumstances new employees could still apply for a mortgage.

What brokers had to say

Here’s what a sampling of mortgage brokers had to say about the factors that would favour a mortgage application while still on work probation:

“It depends a lot on who the employer is. I have had exceptions for CN employees, cops, standard government jobs.”
– Justin Foulis, Mortgage Advantage in North Vancouver

“I’ve had success across the A-lending universe with police, EMS, fire, nursing, doctors, teachers, etc., primarily due to the work and education required to obtain the job in the first place.”
– Adrian McInerney with Oriana Financial

“If it’s the same industry and they have a two-year history, it’s usually pretty safe. More so in a high-demand industry like nursing, programming or trades…that’s usually OK. Multiple recent job changes, a new industry or no two-year income average is a hard sell.”
– Monica Parkin, Invis in Courtenay, B.C.

“Same industry, good tenure previously, and overall good file, I have never had an issue.”
– Ryan Sims with TMG The Mortgage Group in London, ON

“I always want to know that it makes sense. Same industry? Check. Better income? Check. Closer commute? Check. Not habitually changing jobs? Check. I always call an underwriter first to see that they will get behind this. But if it’s a prudent move, I have had lenders make the exception.”
– J.D. Smythe, Dominion Lending Centres Central in Mississauga, ON

“It depends on the file. Someone with weaker credit, next to no assets who have bounced around a bit…..probably not. It depends on the layers of risk.”
– Julie Malo, Paragon Mortgage Inc. in Timmins, ON

Can high-ratio purchasers qualify for a mortgage if they are on probation?

If your lender can get behind it and make the case for the applicants, there is a decent chance the insurer will go along. For example, Sagen’s website clearly states, “Applicants are to be qualified based on the lender’s probation policy.”

Mortgage maven Ron Butler from Butler Mortgage notes that the process can be fairly straightforward. “You make the case to the lender to waive probation, and in the case of a high-ratio mortgage, the lender sends it to the insurer, the insurer approves, and bingo, done,” he said. “Conventional probation is purely a lender decision, typically a risk sign-off and done. It doesn’t matter which lender, it’s the same process everywhere.”

Can a borrower change jobs prior to the funding date?

Once an applicant is approved for a mortgage, we normally advise they stay put till the mortgage is funded. No sudden moves or changes to your personal or financial circumstances, is an oft-heard broker mantra.

But some homebuyers want or need to change jobs in the middle of the purchase process. They do not want to pass up a golden career opportunity.

Even in this case, getting their mortgage approved may still be possible. It always comes down to the same things.

“I have had a 99% success rate with this situation,” noted Andrew Galea, VP of Digital Sales at MortgagePal. “As long as you can relate the previous occupation with the new job, you should be fine.”

He adds that it all comes down to risk management and the propensity for the client to be successful in the new job so they can still be employed after probation. “Where the trouble lies is when it’s a totally new industry or profession and the odds of failure increase,” he added.

The takeaway

Myself, I see this happening most often with Information Technology professionals and engineers. Their skill sets are very much in demand. Once they have had a few years of successful employment under their belt, it seems they can move around with impunity.

That said, it’s best to just depend on having the base salary accepted, because including an additional two-year average of commission and bonus income from a previous job is going to be much more challenging.

If a probationary period is in your picture, you need peace of mind and certainty. This is one of several factors affecting whether or not your mortgage will be approved. Ask your mortgage broker or banker to get the lender’s sign-off before you firm up your purchase plans.

–Ross Taylor

2022 Housing and Interest Rate Forecasts

For the second straight year—and in the face of an ongoing pandemic—the Canadian real estate market has continued to defy gravity.

Projected figures for 2021 suggest home sales will end the year 21% higher than 2020 (to a total of 668,000 transactions), while home prices will end the year up 21.2% to an annual average of $687,500, according to the Canadian Real Estate Association.

Tight supply has been a recurring theme, with CREA noting the months of inventory measure has fallen below two months worth of supply just four times in history: in February and March of 2021, and again in October and November.

“While price growth is not expected to be as extreme in 2022, many of the conditions that supported it right up until the end of 2021 will still be there on New Year’s Day,” CREA noted in its housing forecast.

While home price growth is expected to moderate in 2022, low supply is still expected to keep upward pressure on prices for much of the year, according to various forecasts that we’ve summarized below.

We’ve also recapped the latest interest rate forecasts for 2022 from the bond market and from analysts at the Big 6 banks. While the exact timing and pace of any Bank of Canada moves is still up in the air, it’s clear that rate hikes are on the horizon.

Real Estate Market

CREA

• 2022 home sales forecast: -8.6% (following a projected 21% increase in 2021)
• 2022 home price forecast: +7.6% (following a projected 21.2% increase in 2021)
• Commentary: “Along with an unprecedented supply crunch, there are quite a few other factors that will play important roles in Canadian housing markets in 2022. Ongoing strong demand from an unobservable but no doubt large number of households waiting for new listings to show up will be one tailwind,” CREA said. “There will also be headwinds, chief among them higher interest rates. While the Bank of Canada has set the stage for a tightening cycle of still indeterminate size to begin as early as April of next year, mortgage rates have already started to move higher, first this past spring, and again in the last few months.”
• Link

Royal LePage

• 2021 house price forecast: +10.5%
• Commentary: “Following more than a year of record price appreciation across the country, Canadian home values are expected to rise strongly again in 2022, however at a slower pace compared to 2021. Pent-up demand from buyers who were unable to transact in 2021, coupled with the growing need for shelter from new household formation and newcomers to Canada, will continue to put upward price pressure on a market suffering from a chronic supply shortage.”
• Link

RE/MAX

• 2022 house price forecast: +9.2%
• Commentary: “RE/MAX is anticipating steady price growth across the Canadian real estate market in 2022, with inter-provincial migration continuing to be a key driver of housing activity in many regions, based on surveys of RE/MAX brokers and agents…The ongoing housing supply shortage is likely to continue, putting upward pressure on prices.”
• Link

RBC

• 2022 home sales forecast: -19.8%
• 2022 house price forecast: +3.3%
• Commentary: “Our view remains that deteriorating affordability (arising from soaring prices or higher interest rates, or both) and easing pandemic restrictions will gradually cool demand in 2022. We expect extremely tight demand-supply conditions will keep prices under intense upward pressure in the near term though we see such pressure easing significantly by the second half of 2022 as markets achieve a better balance.”
• Link (data)
• Link (commentary)

TD

• 2022 house price forecast: +7%
• Commentary: “Higher interest rates are likely on the way and our rate forecasts imply that they will exert a moderate drag on housing demand. However, a supportive macro backdrop, alongside stress tests that offer ample room for rates to rise before buyers are crowded out, should keep activity holding above pre-pandemic levels next year…Affordability has become much tougher due to the rapid escalation of prices during the pandemic. That said, Canada has in its past managed to weather a situation where the cost-of-living situation was even worse without seeing a severe retrenchment in activity. And, both new and resale markets remain drum-tight, suggesting another strong year for price growth is in the cards for 2022.”
• Link (data)
• Link (commentary)

CIBC

• 2022 home sales forecast: -15%
• Commentary: “Overall, we expect sales to fall by 15% in 2022, relative to the elevated level seen in 2021—an environment that is consistent with a notable deceleration in home price inflation next year,” wrote economist Benjamin Tal. “This environment is also likely to impact the relative value of condos vs. single-detached units…Logic suggests that higher rates will channel more activity into the more affordable condo market, resulting in relative price outperformance in that market.”
• Link

Fitch Ratings

• 2022 house price forecast: +5-7%
• Commentary: “The slower growth will be driven by an expected rise in interest rates, inflationary pressures and declining affordability, which will dampen demand…Additional factors that could hinder price growth are new macro-prudential measures (additional stress tests or new taxes on non-owner-occupied homes). These measures would further limit the number of borrowers who qualify for a mortgage or make it less economical to own a non-owner-occupied property, which in turn would limit the number of buyers in the market (both new entrants and people looking to buy a bigger home).
• Link

Interest Rate Forecasts

Below are the latest rate forecasts from the Big 6 banks. Averaging the forecasts, the Big 6 banks expect the overnight rate to rise about 1% by the end of 2022, meaning four quarter-point rate hikes by the Bank of Canada.

Looking ahead to the end of 2023, analysts from the big banks are calling for an additional three rate hikes, bringing the overnight rate to 1.75%.

Meanwhile, the bond market is maintaining its forecast for more aggressive rate tightening by the Bank of Canada.

As of Tuesday, it is still fully priced in for five quarter-point rate hikes by the end of 2022, which would bring the overnight target rate to 1.50%.

–Steve Huebl

2021 – Year in Review

As we turn the page on yet another tumultuous year headlined by Covid and its emerging variants, we wanted to take a look back at some of the top mortgage-related stories of 2021 and how mortgage rates fared.

Consumers grappled with rising prices in all aspects of the economy, including, of course, in Canadian real estate. As of November, the average price hit a record-high of $720,854, up over 20% from a year earlier. Rising prices led to record growth in mortgage credit over the year as homebuyers were forced to take out ever-growing mortgages.

And while fixed mortgage rates rose in 2021, they still remain low historically. That’s even more true for variable mortgage rates, which became the mortgage product of choice for a growing percentage of borrowers this year. But all eyes are looking ahead to 2022, with speculation abounding as to when and by how much the Bank of Canada will raise lending rates.

Here’s an overview of some of the year’s top stories, rate movements and mortgage-related stock performance.

Top Mortgage Stories of 2021

• Home prices soared in 2021 as demand outstripped supply (Story)
• Fixed mortgage rates climbed over the course of the year (Story)
• The Bank of Canada acknowledges high inflation could last longer than expected (Story)
• Mortgage credit reached new heights (Story)
• Borrowers faced a more stringent mortgage stress test (Story)
• Sagen overtook CMHC as Canada’s largest mortgage insurer (Story)

This Year’s Top Deals & Lender Moves

• MCAP Acquired Paradigm Quest and Merix (Story)
• Non-Bank Lender CMLS Launches a HELOC (Story)
• Mortgage Brokers Get TD’s HELOC (Story)
• Newly Launched Fundible Allows Canadians to Buy Before Selling (Story)
• Meet Bloom, Canada’s Newest Reverse Mortgage Provider (Story)
• The Broker Channel Gets Another Prime Lender: Strive Capital (Story)

Rate Movements

The foundation for Canadian interest rates is the overnight rate, which finished the year where it began. Meanwhile, the most important benchmark for fixed-rate pricing—the 5-year government bond—ended the year up nearly 90 basis points, which resulted in higher fixed rates for many mortgage borrowers.

Stock Moves

And finally, here’s a look at the performance of Canada’s big banks and public companies that make the majority of their revenue in the mortgage business.

–Steve Huebl

Minimum Qualifying Rate for Both Mortgage Stress Tests Left at 5.25%

As part of its annual review of the stress test for uninsured mortgages, the Office of the Superintendent of Financial Institutions today confirmed the minimum qualifying rate will remain at 5.25%.

That means borrowers making a down payment of 20% or more will need to prove they can afford payments based on their contract rate plus 2% or 5.25%, whichever is higher. Currently, about 90% of mortgage borrowers are being qualified at the 5.25% minimum qualifying rate (MQR) rate as opposed to their contract rate plus 2%, OSFI said.

The Department of Finance followed suit by leaving the MQR unchanged for insured mortgages, or those putting down less than 20%.

“Maintaining the current minimum qualifying rate will ensure prudent underwriting standards for insured mortgages,” read a joint statement from the Deputy Prime Minister and the Minister of Finance. “We will continue to monitor the housing market and review the minimum qualifying rate in order to adjust it as warranted.

OSFI said it made its decision based on the current environment of increased household indebtedness and low interest rates, adding it is essential that lenders continue to test borrowers to ensure they can afford their mortgages “during more adverse conditions.”

“Sound mortgage underwriting is critical for maintaining the stability of the financial system,” Peter Routledge, Superintendent of OSFI, said in a statement. “This is especially true now when changing conditions such as potentially rising interest rates could make repaying mortgages more difficult in the future.”

On a media conference call following the announcement, Assistant Superintendent Ben Gully said OSFI considers a range of factors when assessing the MQR, including interest rate sensitivity, changes in borrowers’ income, changes in house prices or imbalances and lenders’ funding costs.

He added that the supply and demand imbalance in the housing market is a “long-term prudential risk.”

“A sustained, multi-year imbalance between housing demand and supply intensifies risk to Canada’s housing market and to Canada’s system of housing finance. The imbalance tends to drive price increases to ever-higher levels relative to income. This, in turn, induces more Canadians to resort to more leverage when buying  a home.”

OSFI reviews the MQR each December and said it will make further adjustments “if conditions warrant.”

“We will continue to monitor housing markets across Canada and apply our supervisory focus to both changes in the market and lenders’ practices,” Gully said.

Stress Test Tightened in 2021

OSFI introduced its stricter stress-test for uninsured mortgages in June, which was promptly adopted by the Department of Finance for insured mortgages. The MQR for the stress test was previously 4.79%, nearly 50 basis points lower.

The change was estimated to have reduced purchasing power for new buyers by between 4% and 5%.

Economists from National Bank had estimated that under the new qualifying rate, the maximum amount that could be borrowed would decrease by 4.5%, or from $442,000 to $422,000 for a median-income household, they wrote.

OSFI Sees “Modest” Risk in Housing Credit

Asked why OSFI didn’t raise the floor rate today, Gully said mortgage credit risk has risen “only modestly.”

“While housing-related vulnerabilities remain elevated, residential mortgage credit risk has risen only modestly,” he said. “Our view is other measures taken by OSFI and other federal financial sector agencies have contributed to a margin of safety in the market.”

His comment echoed remarks from OSFI head Peter Routledge last month. Since then, house prices in Canada have continued to rise, reaching a record high $720,850 in November, according to the Canadian Real Estate Association. That’s up over 19% compared to a year ago.

“Despite this exuberance and rising mortgage credit levels, Canadians are dedicating less income to debt service payments such as mortgage payments, automobile loans and credit card payments,” Routledge said at the time.

Overall, residential mortgage credit growth is rising at a pace of about 10% annually, he added.

Gully was asked if anticipated interest rate hikes in 2022 from the Bank of Canada played any role in OSFI’s decision to leave the MQR unchanged, but he pointed to the dynamic structure of the stress test that already accounts for interest rate fluctuations.

The mortgage stress test is “designed to reflect a range of different mortgage interest rates,” he noted. “There’s an acknowledgement that rates can change over time and that’s why we’ve built a mechanism that preserves a margin of safety for borrowers to account for a range of outcomes,” with Bank of Canada interest rate increases being one of them, he added.

(Story updated)

–Steve Huebl

The Bank of Canada’s Big Pivot on Inflation

The Bank of Canada is finally coming around to the view that the rising cost of goods and services is perhaps not so transitory after all.

The following is the key line from the Bank’s most recent Monetary Policy Report:

“The recent increase in CPI inflation was anticipated in July, but the main forces pushing up prices—higher energy prices and pandemic-related supply bottlenecks—now appear to be stronger and more persistent than expected.”

It has been clear for months now that this was not a base effects issue (i.e., inflation is only high now because it was so low last year), which was one thing we heard from pundits earlier this year. The September Consumer Price Index (CPI) inflation report provided further confirmation with one of the strongest three-month increases in core CPI (seasonally adjusted) since the early 2000s. Inflation is happening in real-time.

We’re also seeing the breadth of inflationary pressures expanding beyond industries initially affected by supply chain disruptions. The number of CPI sub-components seeing increases of more than 3% is the highest it’s been since the early 1990s.

And things aren’t cooling down, either. The price of raw materials purchased by manufacturers increased 2.5% month-over-month in September and was up a whopping 31.9% year-over-year, while the Industrial Product Price Index, which measures the price of finished manufactured goods, registered a 1% monthly increase and was still up 0.6% even once volatile energy prices were stripped out. It’s now up 15% annually overall, the highest reading since the series began in the early 1980s. Those prices will flow through to consumers in due time.

Signs point to high inflation persisting long-term

There’s no reason to think inflationary pressures are set to abate anytime soon.

For starters, price plans hit a new record in the latest CFIB (Canadian Federation of Independent Business) Small Business Barometer. This series has an excellent track record of predicting core inflation trends six months out. Nearly half of respondents are now expecting to raise prices by more than 5%, which is a record for the series by a wide margin.

Meanwhile, the monetary base continues to expand rapidly with M2, a broad measure of the money supply, now growing 11% year-over-year versus a 6.3% average since 1990. The two-year change is over 30%, the highest it’s been in nearly 40 years.

So, all of this points to more inflationary pressures ahead.

What’s generally needed to sustain inflation over the longer term is a broad increase in wages. While that’s not in the official data yet, it’s likely only a matter of time.

Another factor to look at is the share of businesses reporting labour shortages, which set a new high again in October. And this is at a time when hiring intentions among businesses are the strongest on record:

This suggests that workers finally have bargaining power again, and it’s happening at a time when they are starting to feel the pinch from rising prices. It all points to strong wage growth ahead.

The impact on interest rates

So, what does all this mean for interest rates?

Clearly, the Bank of Canada is taking on a more hawkish tone and is rightfully concerned about rising prices. But, how much room do they actually have to move rates before causing real pain in the broader economy?

Markets are now pricing in five quarter-point rate hikes by this time next year, but let’s think about what that would mean.

If we look at the household debt service ratio and make some conservative assumptions regarding aggregate income growth (1% per quarter) and debt growth (1.5% per quarter) and then model out an 80-basis-points rise in the effective interest rate—which is about the flow-through in one year from a 125-bps hike—we would hit new all-time highs by early 2023.

Now, if income growth really takes off, it will certainly help. And the record pile of excess household savings, currently estimated at a quarter of a trillion dollars, would also act as somewhat of a buffer. But this would still slam the brakes on consumption and housing investment, which, combined, have accounted for nearly 85% of real GDP growth over the past year.

And that’s just the impact on households. Broaden things out to include non-financial businesses and we end up with a combined debt-service ratio of 23% and total debt-to-GDP equivalent to 240% of GDP…66 points above the G20 average.

This level of indebtedness is exactly the sort of limiter that will make it very difficult for the Bank to normalize interest rates.

Instead, they will likely be more inclined to let prices run hotter than they have in previous cycles and allow inflation to eat away at the burden of debt over time. In fact, a Bank of Canada staff analytical note released this summer, appropriately titled Exploring the Potential Benefits of Inflation Overshooting, is about as clear a signal as they could give on this front.

The days of ultra-cheap mortgages may be behind us, but at this point, the fear of rising rates is likely overblown.

This piece was originally published in Mortgage Professionals Canada’s Perspectives magazine (Issue #4, 2021).
Article feature image by David Kawai/Bloomberg via Getty Images

–Ben Rabidoux