Bank of Canada Rate Cut Is Driving Mortgage Costs Higher

The Bank of Canada (BoC) recently reduced its overnight rate by 0.25 percentage points to 2.75%. While this move was intended to stimulate borrowing and economic activity, it has led to unexpected consequences for mortgage costs, particularly affecting those with fixed-rate mortgages.

Variable-rate mortgage holders experienced immediate benefits from the rate cut, with some of the lowest nationally advertised rates dropping to 4.25%. However, these mortgages represent a smaller segment of the market, as many Canadians prefer the predictability of fixed-rate mortgages. The rates for these fixed products are closely tied to the Government of Canada’s 5-year bond yields.

Following the BoC's announcement, the 5-year bond yield increased, closing at 2.673% shortly after the rate cut. This uptick in bond yields exerts upward pressure on fixed mortgage rates. For instance, a homebuyer purchasing a $1 million property with a 20% down payment might face approximately $2,000 more in interest over the mortgage term due to these rising yields.

The increase in bond yields is largely driven by heightened inflation expectations among investors. When investors anticipate higher inflation, they demand higher returns on bonds to compensate for the decreased purchasing power, leading to increased bond yields. These higher yields subsequently result in elevated fixed mortgage rates.

Complicating matters, the BoC's rate cut coincided with expectations of rising inflation, partly due to the expiration of temporary tax measures like the GST/HST Tax Holiday. This timing has raised concerns that the central bank's actions might inadvertently fuel inflationary pressures, potentially necessitating future rate hikes to stabilize the economy.

In summary, while the BoC's rate cut aimed to make borrowing more affordable, its impact on fixed mortgage rates has been counterintuitive. Prospective homebuyers and current mortgage holders should closely monitor these developments and consider consulting financial advisors to navigate the evolving landscape.