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Ukraine war, inflation cited as Bank of Canada rate hits 1 per cent

Rate increases will make qualifying under mortgage stress test harder for many homebuyers
Bank of Canada governor Tiff Macklem | Bank of Canada

The Bank of Canada hiked its key rate by 50 basis points April 13 in a race to tamp down inflation, which has been hitting highs not seen since the early 1990s.

The overnight rate now stands at 1 per cent and economists widely expect about a half-dozen more rate-hikes to follow in the coming year, although not all of those rate-hikes are expected to be as high as 0.5 per cent (the largest hike since May 2020).

The central bank raised its key rate last month by 25 basis points – its first hike since 2018 – after inflation hit 5.7 per cent in February.

“Russia’s ongoing invasion of Ukraine is causing unimaginable human suffering and new economic uncertainty. Price spikes in oil, natural gas and other commodities are adding to inflation around the world. Supply disruptions resulting from the war are also exacerbating ongoing supply constraints and weighing on activity,” the Bank of Canada said in its announcement.

“These factors are the primary drivers of a substantial upward revision to the Bank’s outlook for inflation in Canada.”

There had been signs long before Russia’s invasion of Ukraine that inflation was becoming increasingly problematic.

Going into 2022, the overnight rate had been sitting at 0.25 per cent since the outset of the pandemic as the central bank aimed to inject cheap capital into the economy as the COVID-19 crisis unfolded. The federal government had also been earmarking billions of dollars to keep business activity charged amid the uncertainty.

At the same time demand for services such as tourist activities or in-person events had dropped during the pandemic, many Canadians found themselves sitting on additional savings and directed much of their dollars towards buying goods. That in turn put pressure on prices.

The global economy also bounced back significantly in 2021, putting further demand on labour markets after many had been laid off the year before. The additional demand for labour had put pressure on wage hikes as well.

The Bank of Canada is now forecasting inflation will average 6 per cent in the first half of 2022 before easing to 2.5 per cent in the second half of 2023 and 

It also forecasts the economy growing 4.25 per cent this year before slowing to 3.2 per cent next year and 2.25 per cent in 2024.

“Robust business investment, labour productivity growth and higher immigration will add to the economy’s productive capacity, while higher interest rates should moderate growth in domestic demand.”

BMO chief economist Douglas Porter said the Bank of Canada's commentary suggests big hikes aren't done just yet, with another 50 basis point jump potentially coming in June.

Porter said in a note BMO now sees the Bank of Canada hiking a further 125 basis points this year to end at 2.25 per cent. BMO had previously been forecasting 2 per cent.

“With inflation pushing towards 6 per cent, the labour market at full employment and output pushing on capacity constraints, the [Bank of Canada] needed aggressive action,” TD senior economists James Orland said in a note. “By raising the policy rate by 50 basis points for the first time in 22 years, the BoC is setting the pace for more aggressive moves in the coming months.”

“Higher and faster rate hikes will affect mortgage affordability for a significant population of homebuyers,” mortgage broker Sung Lee of told Western Investor.

“Major banks have already pushed fixed rates higher several times over the past few weeks with some approaching the 4 per cent mark for uninsured products. Lenders are also decreasing the variable rate discount from prime. As mortgage rates rise, not only do borrowing costs become more expensive, it can also mean that potential homebuyers are qualifying at a rate higher than the current stress test of 5.25 per cent.” 

Both insured and uninsured mortgage borrowers are qualified under the federal stress test based on the higher of the benchmark rate of 5.25 per cent or the mortgage contract rate plus 2 per cent. While 5.25 per cent has been the higher of the two in most cases since June of 2021, this has begun to change for fixed-rate borrowers. For borrowers with a rate of more than 3.25 per cent, they will need to qualify at the higher rate which will decrease the total amount they can borrow.