Rate increase forecasts are under question in Canada because of Omicron

The new Omicron variant and forecasts of further high inflation are making some doubt current rate-increase predictions.

Although bond markets still expect five rate hikes in 2022 per 0.25% each, leading the overnight rate to 1.50%, others say it will hardly happen.

“Investors are reducing their bets for rate increases in 2022 due to Omicron worries,” – wrote analyst Ben Rabidoux in Edge Analytics report.

He says the 5-year bond yield, which usually affects fixed mortgage rates, went down by about 0.30% from its previous high level in October.

According to Rabidoux, excessive debt levels will limit the central bank’s ability to raise rates.

“This is the level of indebtedness that will make it very difficult for the Bank of Canada to normalize interest rates,” – he noted. “Instead, the BoC will probably let prices go even higher than during the previous cycles and allow inflation to eat away at the burden of debt eventually.”

So what does it mean for Canadian borrowers?

If the central bank chooses a more gradual tightening pace, the Government of Canada bond yields will most likely stay below their recent peak and start falling in the coming months.

For those thinking about a variable-rate mortgage, rate increases are still on the table. “In my opinion, if you have a variable-rate mortgage or you’re considering getting it, you need to be prepared for rate hikes,” – he added. “I think there will be fewer gains than the bond market is currently expecting, but some hikes are inevitable.”

Pointing to the BoC’s data, Rabidoux noted that variable-rate originations rose by 84% from a year ago, while fixed rate mortgages went down by 52%.

Today’s share of outstanding mortgages exceeds 26% for variable-rate mortgages, marking the highest level since the data was made available in 2016. The reason is that discounted 5-year fixed rates have exceeded 2.50%, which is 1.00% higher from 2020-2021 lows.

At the same time, variable rates are still close to record lows with a spread of about 1.40% compared to fixed rates.

Here are interest rate forecasts from the Big 6 banks

According to the average forecast, the Big 6 banks predict the overnight rate increase by 1% by the end of 2022 (four rate hikes per 0.25%).

In 2023, they expect three more rate increases to 1.75%.

	Target Rate: Year-end ’21	Target Rate: Year-end ’22	Target Rate: Year-end ’23
BMO	0.25%	1.25%	NA
CIBC	0.25%	1.00%	1.75%
NBC	0.25%	1.50%	1.75%
RBC	0.25%	1.00%	1.75%
Scotiabank	0.25%	1.25%	2.25%
TD Bank	0.25%	1.00%	1.75%