Will the Bank of Canada start raising interest rates ahead of the U.S. Fed?

Amid the latest report pointing to a 30-years-record high inflation in the U.S., many wonder who will start acting first.

Over the previous 25 years, the Bank of Canada has raised its key lending rate independent of the Fed during three periods: in 1997-98, 2002-03 and 2010. According to the forecasts concerning the bond market, it may happen again soon.

The moment the BoC realizes it’s losing its fight for the target inflation, it will raise its overnight rate even if the Fed is not ready to act.

While some people believe that low rates don’t support inflation growth and a rate increase will not bring it to the target level of 2%, it still remains the BoC’s main tool. It works, so it will use it without a doubt, even if the U.S. decide to take their time.

That’s why we may see certain divergence between Canadian and U.S. rates, although not a large one. Such a change will raise the Canadian dollar and affect exports negatively.

In case the Fed realizes it has also lost control over inflation, following an inflation hike to a 30-years record high level of 6.2%, it will soon follow Canada’s example.

We’re getting closer to a point where five-year fixed mortgage rates become risky compared to variable ones. Of course, if you believe in the market’s ability to predict rate changes.

The faster interest rates and commodity prices grow, the more rate increases are necessary to reduce inflation. And as a result, the closer we get to the next economic slowdown.

It’s important for mortgage shoppers as economic slowdowns, especially recessions, tend to lead to lower rates.

In addition to it, the Bank of Canada doesn’t have a lot of space for rate hikes, according to RBC Capital Markets: “Canada has less room to tighten aggressively as we are facing elevated levels of household debt.”

In case rates do go up as much as the market expects in 2023, only two rate cuts will be enough in 2024 or 2025 for the current lowest uninsured variable rate (1.30%) to beat a 2.59% fixed rate with similar conditions.

Yes, market forecasts are volatile and can be wrong, so based on the history and economic cycles we still believe that variable mortgage could be a more reasonable option for many well qualified Canadian borrowers.