As was universally expected, the Bank of Canada’s Governing Council hiked overnight rates this morning by 25 basis points taking the benchmark yield to 1-3/4%. This marked the fifth rate increase since the current tightening phase began in July 2017 (see chart below). The central bank stated it would return the overnight rate to a neutral stance, dropping the word ‘gradually’ that was used to describe the upward progression in yields since this process began. Market watchers will certainly note this omission. For the first time in years, the Bank has acknowledged it expects to remove monetary stimulus from the economy entirely.

So what is the neutral overnight rate? According to today’s Monetary Policy Report (MPR), “the neutral nominal policy rate is defined as the real rate consistent with output sustainably at its potential level and inflation equal to target, on an ongoing basis, plus 2% for the inflation target. It is a medium- to long-term equilibrium concept.” For Canada, the neutral rate is estimated to be between 2.5% and 3.5%, which implies that at a minimum, three more 25 basis point rate hikes are likely over the next year or so.

The Bank of Canada emphasized that the global economic outlook remains solid and that the U.S. economy is particularly robust, but is expected to moderate as U.S.-China trade tensions weigh on growth and commodity prices. The new U.S.-Mexico-Canada Agreement (USMCA) eliminated a good deal of uncertainty for Canadian exports, which will reignite business confidence and investment. Business investment and exports have been of concern in recent quarters, and the Bank is now looking towards a resurgence in these sectors, augmented by the recently-approved liquid natural gas project in British Columbia.

A continuing concern, however, is the decline in Canadian oil prices. Western Canada Select (WCS), a local blend that represents about half of Canada’s crude oil exports, has declined about 60% since July as global oil prices have risen (see chart below). WCS plunged below US$20 a barrel last week posting the biggest discount to West Texas Intermediate (WTI) on record in Bloomberg data back to 2008. WCS generally tracks heavy oil from Canada, which typically trades at a discount to WTI because of quality issues as well as the cost of transport from Alberta to the refineries in the U.S.

Canadian pipelines are already filled to the brim. The inability of the Canadian oil industry to build a major pipeline from Alberta to either the U.S. or the Pacific Ocean is increasingly dragging down domestic oil prices. Oil-by-rail shipments to the U.S. are at an all-time high, but this is an expensive and potentially unsafe option and precludes Canadian oil exports to China and Japan.

An even broader concern is the impact of higher interest rates on debt-laden consumers. The Bank is well aware of the risks, as the MPR cited that “consumption is projected to grow at a healthy pace, although the pace of spending gradually slows in response to rising interest rates… Higher mortgage rates and the changes to mortgage guidelines are affecting the dynamics of housing activity. Housing resales responded quickly to the new mortgage guidelines, and the level of resale activity is expected to continue on a lower trajectory than before the changes. New home construction is shifting toward smaller units, although stronger population growth is estimated to raise fundamental demand for housing.”

Household credit growth has slowed, and the share of new mortgages with high loan-to-income ratios has fallen. The ratio of household debt to income has levelled off and is expected to edge downward (see chart below).

Low-ratio mortgage originations declined by about 15% in the second quarter of 2018 relative to the same quarter in 2017 (see charts below). The MPR shows that “while activity fell for all categories of borrowers, the drop was more pronounced for those with a loan-to-income ratio above 450%, leading to a decline in the number of new highly indebted households”.

Bottom Line: The Bank of Canada believes the economy will grow about 2% per year in 2018, 2019 and 2020, in line with their upwardly revised estimate of potential growth of 1.9%. The Bank asserts that mortgage tightening measures of the past two years have “reduced household vulnerabilities,” although the “sheer size of the outstanding debt means that vulnerability will persist for some time”. That is Bank of Canada doublespeak. What it means is expect three more rate hikes by the end of next year.

With the Bank of Canada widely expected to increase interest rates Wednesday, a poll from debt advisors MNP shows rising concern over higher rates.

The survey, conducted by Ipsos, found that 1 in 3 Canadians are worried that rising interest rates could push them towards bankruptcy, up 6% since June.

More than half (52%) of respondents said that they are concerned about affording their debts as rates climb, that’s up 3% since June.

The share of those who say they are feeling the effects or recent rate rises; and the share who say future rises could put them in financial trouble; both hit 45%.

Almost two thirds of both Millennial and Gen X respondents are concerned about the impact of interest rate rises on their ability to service debts, while Boomers are less concerned (40%).

The poll reveals that 80% will cut back on spending to counter the effects of rising rates and there is some optimism about debt situations with 28% saying theirs has improved in the past year, 39% expecting improvement in the next year, and 50% saying improvement will be within 5 years.

Two in five said they regret the level of debt they have.

Albertans (20%) are most likely to say their current debt situation is worse, followed by residents of Atlantic Canada (17%), Saskatchewan and Manitoba (15%), Ontario (13%), Quebec (10%), and British Columbia (8%).

Quebec residents (49%) are most likely to rate their personal debt situation as good, followed by residents British Columbia (45%), Ontario (38%), Saskatchewan and Manitoba (34%), Alberta (33%) and Atlantic Canada (28%).

Homeowners could be facing two interest rate rises in the coming months according to an updated forecast.

CIBC Capital Markets said Thursday that it was already expecting a rate rise in October due to anticipation that a NAFTA deal would happen. The agreement of the next-gen trade deal USMCA supports the earlier forecast.

However, economists are now calling for a further rate rise in January 2019, slightly earlier than it had been forecasting. That’s due to recent positive data points.

The good news for homeowners with mortgages is that, following those two rate rises within three months, CIBC Capital Markets believes there will need to be a “prolonged pause” by the BoC due to the “elevated sensitivity of households” to the interest rate hikes.

The outlook also forecasts that the Canadian dollar will strengthen over the next six months or so before easing back to the low 1.30s against the greenback by mid-2019.

Challenges ahead for the economy

CIBC economists Andrew Grantham and Royce Mendes have posted their economic outlook for the coming years and highlighted some challenges.

These include rising mortgage rates, attracting and retaining talent, and a US slowdown by 2020.

Provincially, Alberta is expected to see stronger growth in 2018 than previously predicted due to a resurgence of oil production.

BC is set for weaker growth than expected due to the slowdown in the housing market, which is a key driver of growth in the province. The economists note that there has been a more pronounced slowdown in the BC housing market activity than in Ontario and not much of a rebound so far.

The outlook also suggests a slowdown in consumer spending in BC and Ontario as the provinces see the biggest impact from rising interest rates.

The report highlights that 5-year mortgages will be renewed at higher rates for the first time in a generation.

Interest rates could hit 6% by 2020, according to Moody’s Analytics.

The prediction, using RPS data, is based on policymakers realizing plans to quell housing bubbles in Toronto and Vancouver, as well as on rising interest rates.

“Two macroeconomic projects now dominate housing markets in Canada,” said Andres Carbacho-Burgos, a Moody’s economist. “The first is that the [Bank of Canada] will continue to tighten short-term interest rates through 2020 in order to head off inflation and also maintain the value of the Canadian dollar relative to its U.S. counterpart.

“With some lag, monetary tightening will pull up mortgage rates. The five-year mortgage rate is now at about 4.4% after bottoming out at 3.6% in mid-2017; the Moody’s Analytics baseline projection is that it will continue to increase until it levels off at about 6% in late 2020.”

Prolonged North American Free Trade Agreement negotiations have only deferred the Bank of Canada’s rate hiking mandate, but with the federal government this week finalizing a new deal, the United States-Mexico-Canada Agreement, there will almost certainly be a hike on Oct. 24.

“Overall, when it comes to the new USMCA, it’s going to affect the housing market because interest rates are bound to go up,” said Samantha Brookes, founder of Mortgages of Canada. “The Bank of Canada was holding back the rate until there was an agreement. Now, we’ll get increases based on the way the economy has been performing, and what that means for Canadians is interest rates will go up and prices will continue to adjust.”

That will likely make conditions favourable for buyers as the market continues recovering from the shock of so many changes.

“I believe it will probably take until 2020 until we see some light at the end of the tunnel,” she said. “But that’s based on the correction that’s been happening over the last year. People need to be more creative with how they’re purchasing.”

This could give further rise to co-ownerships in the housing market.

“It’s becoming more and more popular,” said Brookes. “Be creative and you’ll still be able to get in. We all know real estate is still the number one investment, and it will be time to hold onto that investment rather than flipping it for a quick buck. It’s too risky for that right now, so buy and live in your home for a few years until the market corrects.”

The Conservative Party of Canada will make B-20 a hot button issue during next year’s election.

The party’s Deputy Shadow Minister for Finance has already tabled two motions, both of which were rejected by the Liberals, to study B-20’s effects. Refusing to go quietly, MP Tom Kmiec has vowed to put the mortgage stress test back on the agenda in time for the Oct. 2019 federal election.

“It will be an election issue, absolutely,” Kmiec told MortgageBrokerNews.ca. “I’m willing to use procedural tools to get this study done. I’m not necessarily saying to get rid of B-20 completely; I’m saying take a look at the data and then make a decision on it. I’m asking the Liberals to provide any internal documents they have showing why the mortgage rules were introduced in the first place.”

With the Bank of Canada raising interest rates, mortgage qualification has become even more onerous and Kmiec says it’s only going to get worse.

“This is an affordability issue. The Bank of Canada is raising interest rates, and I don’t fault them for it, but rules like B-20, and then provincial rules, are compounding and making it unaffordable for young people to get into their first home,” he said.

“There was a 63% jump in mortgage originations among 73- to 93-year-olds in the first half of this year, which is unusual for the pre-war generation to suddenly take out a whole bunch of mortgages for no apparent reason after B-20 was introduced. It only makes sense when you notice that mortgage originations among millennials are down 19% and Generation Z mortgage originations are down 22%. Are the B-20 mortgage rules causing Canadians to go to their grandparents to take out mortgages for them in their names?”

If that is indeed the case, Kmiec notes that, in the event of a grandparent’s death, messy estate complications will ensue.

According to Victor Peca, a mortgage broker and founding partner of Monarch Mortgage Group, the Liberal Party has deluded itself into believing B-20 is impacting the country positively. However, that isn’t the worst of it.

“The B-20 rules aren’t working because I see a lot more deals coming to me with fraud,” said Peca. “B-20 isn’t stopping that; it’s making it more pronounced because it’s harder to get a mortgage. When someone wants to buy a home, they’ll do whatever it takes to get that picket fence.”

Kmiec has started a website to pressure the Liberals into studying B-20’s effects. He claims the Liberals told him B-20 wouldn’t be examined without more data, which he says has since become plentiful. Having participated in filibustering the electoral reform committee, the Liberals might have underestimated Kmiec’s resolve, not to mention indefatigability.

“If it comes down to it, I’m happy to use up every two-hour time limit on every single committee until we agree to do a mortgage study,” said Kmiec. “I’m not asking for the moon, either. All I want are a few meetings in Ottawa where we can invite people with data who can then tell us what’s happening with the market.”

If NAFTA talks fail or Canada’s inflation runs above acceptable levels, there could be a knock-on effect for the housing market, with a correction possible.

That’s according to the latest outlook from the OECD global policy forum which has updated its outlook to reflect changes since the last report in May.

The outlook for the global economy has been reduced to 3.7% for 2018 and 2018, down 0.1 percentage points, while Canada is expected to grow 2.1% this year (unchanged) and 2% in 2019 (down 0.2 pp).

While the outlook for Canada is essentially strong, driven by exports and a resurgence of the auto and energy sectors, there are still headwinds, especially with high home prices and high levels of household debt.

These include the NAFTA agreement, which if it does not conclude with terms as good or better than the current deal, could stifle growth. A regulatory burden to increasing oil pipeline capacity would also have a negative impact on growth.

Additionally, if inflation rises too high, the Bank of Canada may need to hike interest rates beyond current expectations, which the OECD says could impair the ability of many households to service their mortgages, leading to a housing market correction.

Housing market dangers are “especially acute” in Australia, Hong Kong, Canada and Sweden, Oxford Economics said, noting this has historically posed a threat to economic activity.

“In all four, valuations are very elevated, there has been a lengthy housing boom, debt levels are high and there is a significant share of floating rate debt,” Adam Slater, lead economist at Oxford, said in a research note.

On the positive side, it notes risks are relatively limited in key markets like the U.S., Germany, France, China and Japan. In addition, across most economies there has been no significant recent rise in mortgage rates, which have even fallen in some cases.

“So, the classic ‘trigger’ for house price declines is largely absent,” Slater said. “However, rising rates are not strictly necessary for prices to start falling.”

House prices are falling in Australia, down almost 3 percent in the year through August in major cities, and 5.6 percent in the Sydney market. Meanwhile, three of the nation’s four major banks raised mortgage rates in recent weeks, blaming higher funding costs. The increases came even as the central bank leaves official rates at a record low.

Oxford said it compared markets across OECD countries from 1970 to 2013 and found a clear negative relationship. Where valuations had risen 35 percent or more above the long-term average over that period, real house prices fell 75 percent of the time over the following five years, it said.

“This points to many OECD countries seeing stagnant or negative real house price growth in the next few years: the scope for a further house price ‘melt-up’ in highly valued markets looks extremely limited,” Slater said.

Stretched valuations also matter because house price changes can have a significant impact on economic activity, Oxford said, citing a sample of 83 house price booms. It also found house prices tended to fall after booms, and often substantially.

“For the G7 countries, we find a positive relationship between consumer spending and real house prices from 1997, albeit possibly weakening in recent years,” Slater said.

In a real shocker, Statistics Canada announced this morning that employment dropped by 51,600, retracing most of the 54,100 gain in July. Economists had been expecting a much stronger number, but the Labour Force Survey is notoriously volatile, and job gains continue to average 14,000 per month over the past year. Full-time employment growth has run at about twice the pace at an average monthly increase of 27,000. Labour markets remain very tight across the country.

The unemployment rate returned to its June level of 6.0%, ticking up from 5.8% in July. July’s jobless figure matched a more than four-decade low. At 6.0%, the unemployment rate is 0.2 percentage points below the level one year ago.

All of the job loss last month was in part-time work, down 92,000, while full-time employment rose by 40,400. The strength in full-time jobs is a sign that the labour market is stronger than the headline numbers for August suggest.

On a year-over-year basis, employment grew by 172,000 or 0.9%. Full-time employment increased (+326,000 or +2.2%), while the number of people working part-time declined (-154,000 or -4.3%). Over the same period, total hours worked were up 1.6%.

Statistics Canada commented that monthly shifts in part-time employment could result from movements between part-time and full-time work, the flux of younger and older workers in and out of the labour force, changes in employment in industries where part-time work is relatively common, or deviations from typical seasonal patterns.

By industry, the decline was broadly based and included a loss of 16,400 jobs in construction and 22,100 in the professional services sector. The number of people working in wholesale and retail trade declined by 20,000, driven by Quebec and Ontario.

Job losses were huge in Ontario as employment increased in Alberta and Manitoba. Employment was little changed in the other provinces.

After two consecutive monthly increases, employment in Ontario fell by 80,000 in August, which was the province’s most significant job loss since 2009. All of the decline was in part-time work. On a year-over-year basis, Ontario employment increased by 79,000 (+1.1%). The Ontario unemployment rate rose 0.3 percentage points in August, to 5.7% (see table below).

In Ontario, full-time employment held steady compared with the previous month, with year-over-year gains totalling 172,000 (+3.0%). Part-time jobs fell by 80,000 in August, following a roughly equivalent rise in July. In the 12 months to August, part-time work decreased by 93,000 (-6.7%).
Employment in Alberta rose by 16,000, and the unemployment rate remained at 6.7% as more people participated in the labour market. Compared with August 2017, employment grew by 53,000 (+2.3%), mostly in full-time work.

In Manitoba, employment rose by 2,600, driven by gains in part-time work, and the unemployment rate was 5.8%. On a year-over-year basis, employment in the province was unchanged, while the unemployment rate increased 0.8 percentage points as more people looked for work.

In British Columbia, employment edged up and the unemployment rate increased 0.3 percentage points to 5.3% as more people searched for work. Compared with a year earlier, employment was virtually unchanged.

Wage gains decelerated to their lowest level this year as average hourly earnings were up 2.9% y/y, the slowest pace since December.

There is no real urgency for the Bank of Canada to hike interest rates as the economy shows little risk of overheating. So far in 2018, the economy has shed 14,600 jobs, but the number masks a 97,300 gain in full-time work. Part-time employment is down by 111,900 this year.

The economy is running at or near full-employment as job vacancies continue to mount. If a NAFTA agreement comes to fruition, it is still likely the Bank of Canada will raise interest rates once again at the policy meeting in October. The Bank of Canada guided in that direction yesterday when Senior Deputy Governor Carolyn Wilkins said the central bank’s top officials debated this week whether to accelerate the pace of potential interest rate hikes, before finally choosing to stick to their current “gradual” path.

Canada’s economy is adjusting well to higher borrowing rates and tighter mortgage lending restriction.

That was one of the key messages from the Bank of Canada’s senior deputy governor Carolyn Wilkins in a speech to the Saskatchewan Trade & Export Partnership on Thursday.

She spoke about the BoC’s decision this week to keep interest rates on hold but made it clear that higher rates are coming, albeit in small steps.

Inflation remains the main reason for the rate rise and she reinforced the bank’s assessment that the economy, both domestic and global, is positive.

Ms. Wilkins said that interest rates remain low compared to what would be considered a ‘neutral rate’, which the bank has clarified is in the 2.5-3.5% range.

Economy on target but volatile

The Canadian economy should operate near potential over the next couple of years, she added, but said that the quarterly GDP profile would remain volatile for the rest of 2018.

With a spike in exports in Q2 likely to ease and outages in the oil sector also expected to weigh on growth, Q3 data may be weaker; but the BoC is still expecting growth of around 2%.

She said that recent GDP data supported the bank’s decision to increase rates in July and she noted that household consumption and home renovations data showed that Canadians are generally adjusting well to the higher rates.

Housing market stabilizing

Ms. Wilkins spoke about the housing market, noting that there have been impacts of policy decisions on the resale market.

This has been prominent in the Toronto and Vancouver markets but there are signs of improvement, especially in Toronto, but also other urban areas such as Regina and Saskatoon. Vancouver activity and price growth remain subdued.

Overall though, the signs are that borrowers and mortgage lenders are coping with higher rates and tighter mortgage rules.

There is also an improvement in household credit growth and in the quality of new uninsured mortgages.

In conclusion, Wilkins said: “Recent data reinforce Governing Council’s assessment that higher interest rates will be warranted to achieve the inflation target. We will continue to take a gradual approach, guided by incoming data.”

She added that the BoC will continue to assess the impact of higher rates and how that might be changed by NAFTA and other trade policy developments.

OTTAWA _ The Bank of Canada’s decision to leave its interest rate unchanged Wednesday could be just a brief pause that comes as it carefully follows the unpredictable twists in the country’s trade talks with the United States.

The central bank kept its benchmark at 1.5 per cent, but many experts predict another increase could arrive as early as next month.

In a statement Wednesday, the Bank of Canada said more hikes should be expected thanks to encouraging numbers for business investment, exports and evidence that households are adjusting to pricier borrowing costs.

The bank, however, also made a point of saying it’s closely watching the renegotiation of the North American Free Trade Agreement and other trade policy developments, which could have negative impacts on the Canadian economy. It’s particularly concerned with the potential implications for inflation.

Last week, U.S. President Donald Trump announced he had reached a bilateral trade agreement with Mexico that would replace the three-country NAFTA. He put pressure on Canada to join the U.S.-Mexico deal, but after fresh talks restarted last week Ottawa and Washington have so far been unable to reach an agreement.

Trump notified Congress last Friday of his intention to sign a trade agreement in 90 days with Mexico _ and Canada, if Ottawa decides to join them. If a deal can’t be reached, the president has also repeatedly threatened to impose punishing tariffs on Canadian auto imports.

Frances Donald, senior economist for Manulife Asset Management, said the Bank of Canada’s explicit mention of NAFTA in Wednesday’s statement suggests the negotiations have become even more important around the governing council’s table.

“They’re sending a message that everything looks as planned… What that says to me is that an October rate hike is still certainly in play,” Donald said about the

However, she said the NAFTA reference gives the Bank of Canada options to possibly stay on hold next month, particularly if trade talks _ and the outlooks for the economy and inflation _ deteriorate.

Governor Stephen Poloz, she added, has been “fairly agnostic” on the outlook for NAFTA. She said he’s pointed to potential negatives as well as positives, while the stressing everything is hypothetical until something is decided.

Benjamin Reitzes of BMO Capital Markets wrote in a note to clients that Wednesday’s statement makes it clear the NAFTA talks are biggest issue for markets and the Bank of Canada at the moment.

“There’s big time risk here, but most are still expecting a deal to get done,” Reitzes wrote as he referenced the apparent month-end deadline for NAFTA negotiations.

“Assuming all goes well with NAFTA (perhaps a big assumption) and the data over the next seven weeks, an October rate hike still looks like a reasonable expectation.”

Poloz has raised the rate four times since mid-2017 and his most-recent quarter-point increase came in July. The next rate announcement is scheduled for Oct. 24.

The Bank of Canada said Wednesday that the economy has seen improvements in business investment and exports despite persistent uncertainty about NAFTA and other trade policy developments.

“Recent data reinforce governing council’s assessment that higher interest rates will be warranted to achieve the inflation target,” the bank said as it explained the factors around its rate decision.

“We will continue to take a gradual approach, guided by incoming data. In particular, the bank continues to gauge the economy’s reaction to higher interest rates.”

The statement also pointed to other encouraging signs in Canada, including evidence the real estate market has begun to stabilize as households adjust to higher interest rates and new housing policies. Credit growth has moderated, the household debt-to-income ratio has started to move down and improvements in the job market and wages have helped support consumption, it said.

The bank can raise its overnight rate as a way to keep inflation from running too hot. Its target range for inflation is between one and three per cent.

Heading into Wednesday’s rate decision, analysts widely expected Poloz to hold off on moving the rate _ at least for now.

Last month, Poloz stressed the need to take a gradual approach to rate increases in times of uncertainty. He made the remarks during a panel appearance at the annual meeting of central bankers, academics and economists in Jackson Hole, Wyo.