The recent half-percentage point worth of rate cuts delivered by the Bank of Canada over the past two months may have provided some relief for select borrowers, but forecast suggest there’s much more to come.
Just how much depends on which forecast you follow. Among the current Big 5 banks’ predictions, borrowers are undoubtedly hoping that those by TD Bank and CIBC come to fruition, with both predicting that the Bank of Canada will cut rates by another 175 bps by the end of 2025.
That would bring the overnight target rate back down to 2.75%, comfortably within the Bank of Canada’s neutral range of between 2.25% and 3.25%, and a level not seen since early 2022.
This ambitious prediction stands out when compared to forecasts from other major banks.
At the high end, BMO see the Bank of Canada lowering rates by just one percentage point (100 bps) more by the end of 2025. Meanwhile, Scotiabank expects the central bank will reduce its overnight rate to 3.25%, while RBC projects a 3% overnight target rate by Q4 2025.
“An economy sitting at full employment and on-target inflation will in theory be one requiring interest rates to be at a neutral setting, which the Bank (and CIBC) see at 2.75%,” noted CIBC’s Avery Shenfeld. “Barring an economic shock, that’s a reasonable forecast for where 2025 will end up.”
Shenfeld adds that the Bank will likely take its time in the current easing cycle, with rate pauses dotted in between the rate cuts, particularly in response to economic data that may give the Bank of Canada reason for pause.
“As we’ve seen in the CPI news, economic data don’t follow a straight line path, and such pauses are more likely to be seen if there is a non-trivial upside surprise in employment, growth or inflation,” Shenfeld added.
In responding to CMT’s inquiry about TD’s forecast, senior economist James Orlando said the focus will largely be on one key factor. “I think inflation is the main indicator to watch,” he told us. “That and a continued confirmation of economic weakness.”
And so far, that’s exactly what the Bank of Canada has seen.
In its latest Monetary Policy Report, the Bank of Canada revised down its GDP growth forecasts while its inflation forecast remain largely on track to reach its 2% target level by 2026.
| 2024 | 2025 | 2026 | |
|---|---|---|---|
| Real GDP growth | +1.2% (vs. 1.5% April forecast) | +2.1% (vs. 2.2%) | +2.4% (vs. 1.9%) |
| CPI inflation | +2.6% (no change) | +2.4% (vs. 2.2%) | +2% (vs. 2.1%) |
TD sees long-term growth decelerating below its long-term average to a growth rate of 1.8% annually. At the same time, it seem population growth decelerating and consumer spending experiencing a period of below-trend growth through 2026 “as Canadian households save more in the face of high mortgage debt.”
As a result, TD doesn’t see the Bank of Canada stopping at a 2.75% overnight target rate in 2025. By 2026, it expects the Bank’s benchmark rate to return to 2.25%—or another 225 basis points worth of easing—to a level not seen since mid-2022.
“With inflationary pressures easing over the medium term, the Bank of Canada will be able to cut its policy rate back to the neutral rate of 2.25% by 2026,” reads a recent forecast released by the bank. “We [also] expect the loonie to return to the 75 U.S. cent level once Canadian economic growth is able to catch-up to that of the U.S.”
A history of BoC rate cuts
That’s wouldn’t be out of the realm of possibility looking at past Bank of Canada easing cycles.
As National Bank Financial points out, such consistent and drawn out easing cycles aren’t unheard of.
In the 2001 easing cycle, the Bank of Canada delivered 11 consecutive rate cuts, reducing the overnight rate from 5.75% to 2.00%. This amounted to a total reduction of 375 basis points over 12 months.
This rapid and significant reduction in rates was part of the Bank’s effort to counteract the economic slowdown following the dot-com bubble burst and the aftermath of the September 11 attacks.
CIBC points out that in most previous easing cycles, the Bank of Canada returns its policy rate back to its neutral level within one or two years, with a notable exception being during the 2014 oil price shock where rates were already below neutral and stayed below throughout that period.
“Canadian real rates tend to gradually move towards or stay close to the neutral rate in soft landings, while in the U.S. there are more abrupt adjustments due to hard landings,” CIBC’s Avery Shenfeld notes.
“These differences might simply reflect the greater sensitivity of the Canadian economy to high rates, and thus the greater need to get rates back to neutral territory when the economy shows any meaningful slowing if a recession is to be averted,” he adds.
Implications for mortgage rates
Let’s assume both TD and CIBC are correct in their current forecasts, and the Bank of Canada brings the overnight target rate all the way back down to 2.75% by the end of 2025.
That would suggest a prime rate of approximately 4.95%, given the typical spread between the overnight target rate and the prime rate. For variable-rate borrowers, this would translate into significant savings.
To put it into perspective, a reduction from the current prime rate of 6.70% to 4.95% would lower variable rates—as well as other loans such as personal and home equity lines of credit—by 1.75 percentage points, or 175 basis points.
For every $100,000 in mortgage debt, this reduction would save borrowers approximately $1,250 annually in borrowing costs.
These savings can add up quickly, providing much-needed financial relief for struggling borrowers. For instance, on a $400,000 mortgage, the annual savings would be around $5,000, significantly easing the financial burden on many households.
These savings would benefit approximately 30% of Canadian mortgage holders with variable rates, including both fixed-payment variable mortgages, where the payment remains constant but the interest portion varies, and adjustable-rate mortgages, where payments fluctuate with changes in the prime rate.
While Canadians largely abandoned variable-rate mortgages during the run-up in interest rates, there’s been a renewed interest now that the easing cycle has begun.
As of the first quarter, 12.9% of new mortgage borrowers opted for a variable-rate mortgage, up from a low of 4.2% in the third quarter of 2023, according to figures from the Bank of Canada.
This is still down from a peak of nearly 57% of originations during the pandemic when variable rates were generally lower than fixed rates.
If these rate-cut forecasts come to fruition, we can expect many more borrowers to return to variable-rate mortgages, drawn by the potential for lower monthly payments and reduced interest costs.
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Last modified: July 26, 2024
