The Bank of Canada’s interest rate announcements are among the most closely watched economic events in the country. These decisions reverberate through the economy, affecting everything from consumer spending to the housing market. For homeowners and potential buyers, understanding how these announcements influence fixed and variable mortgage rates is crucial.

The Role of the Bank of Canada

The Bank of Canada (BoC) sets the benchmark interest rate, also known as the overnight rate, which is the rate at which major financial institutions borrow and lend short-term funds among themselves. This rate serves as a foundational reference for other interest rates in the economy, including those for mortgages.

Fixed Mortgage Rates

Fixed mortgage rates are typically determined by longer-term bond yields rather than the overnight rate directly. These rates are influenced by the overall economic outlook and inflation expectations. When the BoC signals a shift in its monetary policy, it can have an indirect impact on fixed mortgage rates through its influence on bond markets.

How Fixed Rates are Affected:

  1. Expectations of Future Rate Changes: If the BoC hints at raising interest rates to combat inflation, investors might expect higher yields on long-term bonds. This expectation can drive up bond yields, which in turn can lead to higher fixed mortgage rates.
  2. Economic Outlook: Fixed mortgage rates are also influenced by the general economic outlook. A robust economy with rising inflation might lead to higher fixed rates, whereas a weaker economy with lower inflation can result in lower fixed rates.
  3. Market Sentiment: Even before any actual change in the overnight rate, the market’s anticipation of the BoC’s actions can cause bond yields to fluctuate, thereby affecting fixed mortgage rates.

Variable Mortgage Rates

Variable mortgage rates, on the other hand, are directly tied to the BoC’s overnight rate. These rates fluctuate based on the central bank’s rate decisions, making them more immediately responsive to changes.

How Variable Rates are Affected:

  1. Direct Impact: When the BoC raises or lowers the overnight rate, variable mortgage rates typically adjust in tandem. A rate hike means higher interest payments for those with variable rate mortgages, while a rate cut results in lower payments.
  2. Immediate Changes: Unlike fixed rates, which are influenced by long-term bond yields and market expectations, variable rates change almost immediately following a BoC announcement. This direct link means that homeowners with variable rate mortgages need to be more vigilant about the central bank’s decisions.

Comparing Fixed and Variable Mortgage Rate Sensitivity

The key difference between fixed and variable mortgage rates lies in their sensitivity to the BoC’s actions:

  • Fixed Rates: More influenced by bond yields and economic expectations. Changes in these rates are often more gradual and are based on broader economic trends rather than immediate policy changes.
  • Variable Rates: Directly influenced by the BoC’s overnight rate. Changes in these rates occur swiftly following rate announcements, making them more volatile in response to the central bank’s monetary policy.

Strategic Considerations for Homeowners

Homeowners and potential buyers must weigh the pros and cons of fixed versus variable mortgage rates, especially in the context of the BoC’s monetary policy.

  • Stability vs. Flexibility: Fixed rates offer stability and predictability in monthly payments, making them attractive during periods of expected rate hikes. Variable rates, however, offer flexibility and can be advantageous when rates are stable or declining.
  • Economic Environment: Understanding the broader economic environment and the BoC’s stance can help in making informed decisions. For example, in a rising rate environment, locking in a fixed rate might provide peace of mind, while a stable or falling rate environment might make a variable rate more cost-effective.

Conclusion

The Bank of Canada’s interest rate announcements play a critical role in shaping mortgage rates. While fixed mortgage rates are influenced indirectly through long-term bond yields and economic expectations, variable mortgage rates are directly impacted by changes in the overnight rate. By understanding these dynamics, homeowners and buyers can make more informed decisions that align with their financial goals and risk tolerance.

To learn more, be sure to watch our recent podcast episode where we dissect the Bank of Canada’s most recent interest rate announcement, S11E11 “What does the recent rate announcement mean for you?”

For more valuable real estate related tips, you can check out the REAL Collective Podcast on iTunes, Spotify or YouTube.