The Inflation Rates — What do They Mean for Your Mortgage?

Inflation has peaked at 3.7%, showing an incredible increase. What would come next? Would inflation continue to rise in 2021 and 2022?

According to Statistics Canada, inflation in Canada reached the highest point in 10 years in July. The damage to the Canadian economy and the extremely high price rises resulted from increased housing costs, the failure of the distribution network, and the mismatch with cheaper costs at the beginning of the pandemic.

The Consumer Price Index (CPI) reached a level of 3.7% in July, showing an incredible year-on-year increase. In June 2021, CPI was 3.1%. In April, May, June, and July of this year, the inflation index exceeded the Bank of Canada’s target range of 1% to 3%, which is considered necessary to keep inflation under control and ensure price stability.

Price increases were broad-based, touching on the cost of various goods: gasoline (up 30.9%), car costs (up 5.5%), food prices (up 1.7%) compared to July 2020 prices. The housing crisis was the main cause of the CPI hike in July, representing a 13.8% year-on-year rise in homeowner replacement costs.

With inflation reaching a ten-year record just before the election, the currency issue has become a hot debate among politicians. Liberal party rivals hope to base their political campaigns on issues such as the cost of living and housing affordability.

Fears of a true inflationary crisis escalating.

As fears of further price increases have gripped the market, the Bank of Canada asserted that it expects inflation to remain above 3% until the end of 2021, while it is forecasted to fall to 2% next year as the overall slowdown in the economy puts downward pressure on prices.

As soon as the situation worsened in July, the Bank of Canada reported that the amount of government bond purchases would be cut from $3 billion to $2 billion in a week.

Previously, at the heart of the COVID-19 pandemic, the Bank of Canada had to do the heavy lifting and implement a strategy of quantitative easing (QE) that involved buying at least $5 billion worth of bonds a week flood the market with liquidity. These measures intended to maintain the yield on five-year bonds, and therefore the interest rate on five-year fixed mortgages, lower than they would be without these measures.

So far, average mortgage rates have been maintained slightly above the historically low levels reached in December 2020. The unresolved question is how long this situation will last.

Outlook for the future

The Bank of Canada adheres to the position that there would be no rise in rates till the end of 2021. The key interest rate will be kept at the low of 0.25% until the economic downturn is absorbed.

Financial markets are forecasting that Canadians can expect a quarter-point hike next year. This will increase the overnight lending rate from the significantly low level of 0.25% to 0.50%.

Although the latest key inflation measure has reached extremely high levels, the bond market is predicting one less rate hike within the next two years than it was a few months ago – three 25 basis point rate hikes instead of four hikes over the next couple of years. A three-year financial forecast predicts a total of five quarter-point rate hikes, which will bring the overnight rate to 1.50 percent.

If the projections come true and the prime rate rises by 125 basis points over the next three years, the average mortgage payment check would increase by about $180 per month. These figures were estimated using today’s average mortgage payment amount and the lowest variable interest rates available nationwide.

The increase in the prime rate will have no immediate impact on borrowers with a constant mortgage rate. They will only feel the increased rates when their loans come up for renewal at maturity or when they decide to refinance.

In a recent statement, analysts at National Bank indicated that they are not worried about a payment shock on renewals; the rise in mortgage rates is likely to reduce the purchasing power of many people.

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