Interest Rates are Rising

Bond yields have edged up since the start of August. Investors seem anxious about how long it has taken to lift restrictions, global supply chain challenges, and growing inflation.

The Bank of Canada has no tools at its disposal that will help with the supply shortages that could continue to stoke inflation. Inflation puts upward pressure on interest rates because investors want to earn more on their investments than inflation. At the same time, strong employment is making it more challenging to justify interest rates below one percent.

There is increasing consensus among central banks that the extraordinary measures introduced during the pandemic are no longer appropriate and that it is time to start normalizing monetary policy. Some central banks have already begun raising their key rates.

While the bank of Canada hasn't raised their target rate above 0.25%, the yields on government bonds have begun to rise, and these have a more direct impact on mortgage rates and home buying budgets.

Compared to a year ago, rates have almost risen a full 1 percent. That might not seem like much, but a rise in mortgage rates from 1 percent to 2 percent doubles the interest costs for borrowers. If rates rise another 1 percent, that's a 50 percent increase in borrowing costs. The chart below illustrates the impact on home buying budgets.

Most forecasts are unchanged. While the exact timing of rate rises varies, there is consensus that rates will rise through the end of 2021 and into 2022.

Despite some concerns about economic growth, the inflation risks are beginning to mount, leading to a path of interest rate normalization.

We expect five-year rates will rise over the next six months. Variable rates are expected to remain at their lower bounds for several more months, perhaps until the second half of 2022.