Mortgage interest cost inflation: How concerning is it for the economy?

Costs soared on a yearly basis as overall inflation ticked upwards in April

Mortgage interest cost inflation: How concerning is it for the economy?

Canada’s annual inflation rate unexpectedly rose in April – and two of the most prominent contributors to that increase were the surging costs associated with holding a mortgage and renting a home.

New figures released by Statistics Canada this week showed that mortgage interest costs ballooned by a huge 28.5% last month from the same time last year, with year-over-year rental costs spiking by 6.1% and accelerating over the previous month.

With overall inflation posting its first annual increase since last June, analysis by banking giant RBC indicated shelter costs accounted for fully a third of that unanticipated growth, which saw the consumer price index (CPI) rise from a March figure of 4.3% to 4.4% last month.

For followers of Canada’s mortgage market, that eyewatering increase in mortgage interest costs will come as little surprise. Interest rates have soared over the past 12 months, with the Bank of Canada taking an aggressive approach on its own trendsetting rate as it battles to curb rampant inflation and fixed rates also ticking upwards.

Claire Fan, an economist at RBC who authored the bank’s economic update in the wake of the latest inflation news, told Canadian Mortgage Professional that the blistering pace of mortgage interest cost appreciation had been widely anticipated, along with a sizeable increase in gasoline prices to push up energy inflation.

RBC expects the trend of spiralling mortgage cost inflation to hit its ceiling in the coming months, assuming the central bank has no further surprises up its sleeve where rate hikes are concerned.

While mortgage interest price levels are likely to remain high, the associated inflation rate is set to moderate “pretty soon,” according to Fan.

“The mortgage interest cost component, we saw that coming,” she said. “We continue to expect it to sort of pick up, but our own forecast is for it to start peaking or peak around mid-summer of 2023.

“That’s our own tracking for mortgage interest costs and that’s just driven by what we have for five-year bond yields in Canada, which is also based on our call for the Bank of Canada to stay put since they paused in March.”

How rate hikes appear to be impacting Canada’s economy

Having remained at a rock-bottom 0.25% throughout nearly two years of the COVID-19 pandemic, the Bank of Canada’s benchmark policy rate – which acts as a leading indicator for the trajectory of variable mortgage rates – has jumped to 4.5% since last March.

The central bank made the final hike of eight consecutive increases in January, opting in its two latest statements in March and April to hold fire on further rate jumps as it weighs up whether further action is required before the end of 2023.

RBC said the “lagged impact” on economic growth of those increases was slowly becoming clearer, suggesting that inflation was broadly on the right path despite inching upwards slightly last month.

How concerned is the Bank of Canada about higher borrowing costs?

The central bank is currently walking a tightrope on interest rates, balancing the need to quell inflation with the prospect of financial distress for many Canadians as a result of dramatically higher borrowing costs.

In its annual report, published Thursday, the Bank emphasized its concerns about the risks high household debt poses to the overall stability of the Canadian financial system, particularly where mortgage costs are concerned.

“Higher debt-servicing costs are stretching budgets and reducing borrowers’ financial flexibility,” Carolyn Rogers, senior deputy governor, said in a statement accompanying the report’s release. “About one-third of households have seen their mortgage payments increase since February 2022, just before the Bank started raising its policy interest rate.”

Rogers noted the risk that a “severe and prolonged recession” could see mortgage defaults rise and result in credit losses for lenders, although she highlighted the fact that Canadian borrowers had traditionally been able to pay their debts “even under stressed conditions,” and that households had shown resilience in the face of rate hikes.

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