Opinion: Bank of Canada rate cuts won’t necessarily reduce mortgage costs

financialpost.com:

By Don Drummond

Media reports abound with speculation about how Bank of Canada interest rate cuts will lift the Canadian housing market. To be sure, you hear cautionary notes that the rate cuts that began with last week’s 25-basis-point cut will likely be slow. Less has been said, however, about how for many homeowners lower rates won’t actually reduce borrowing costs.

Variable-rate mortgages should see a full and immediate response to the rate cuts. But the 2024 CMHC Mortgage Consumer Survey shows only 23 per cent of mortgages are variable rate, five per cent are a fixed/variable combination and 69 per cent are fixed rate. The most common fixed-rate mortgages are for five years although three-year terms have been gaining in popularity.

Fixed-rate mortgages are priced off the corresponding bond yield. Implicit in the anticipation of rate cuts lifting the housing market is an expectation bond yields will move down with Bank of Canada policy rate cuts. In fact, a big decline is unlikely. It would perpetuate today’s inverted yield curve, which has long-term rates lower than short-term rates. That’s not the norm. Because uncertainty increases with time, bond-holders expect to be rewarded for the heightened risk associated with longer terms. Therefore longer rates are usually higher than shorter ones.

To escape the impossibility of guessing the exact timing of Bank of Canada rate cuts, let’s fast-forward to a time, a year or two from now, when the process has been completed. If the economy is operating to the Bank’s satisfaction, the policy rate should be consistent with a “neutral” rate. While the Bank’s estimate could change, at present neutrality is regarded as 2.25-3.25 per cent. If we focus on the mid-point of 2.75 per