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Inflation in Canada is now expected to run a full percentage point above the Bank of Canada’s (BoC) target of 2% through the end of the year.

But the central bank believes—for now at least—that elevated consumer prices will prove temporary as the country’s economic engines fire back up.

"…inflation is likely to remain above 3% through the second half of this year and ease back toward 2% in 2022, as short-run imbalances diminish and the considerable overall slack in the economy pulls inflation lower,” the BoC said following this week’s rate decision. "The factors pushing up inflation are transitory, but their persistence and magnitude are uncertain and will be monitored closely.”

The Bank also said it sees inflation starting to rise again in 2023 as the economy deals with modest excess demand.  

Bank of Canada Ready to Act to Cool Inflation

Consumers, like the central bank, recognize the risk of inflation remaining too high for too long. Not only does it mean elevated prices for everything from gasoline and groceries to furniture and building materials, but it also raises the odds of a swift BoC response in the form of interest rate hikes.

If high inflation persists above the BoC’s target range, "we have the mandate, we have the tools and we will control inflation,” Governor Tiff Macklem told The Canadian Press this week. "We will get it back to target."

But for now, the central bank reiterated that it expects to hold the policy rate at its all-time low of 0.25% until "sometime in the second half of 2022,” at which time rates are expected to start their journey upward.

Bond markets have priced in four 25-bps rate hikes in the next 24 months alone. Looking out over the next five years, the policy rate is expected to rise to around 2.25. Keep in mind this won’t be an immediate increase in rates, but rather a gradual return to more normal levels. And, as with all forecasts, this isn’t a sure bet. Depending on the trajectory of the economic recovery, rates could also stay where they are for longer than expected or rise only slightly.

The Impact on Variable Rates

If the policy rate does rise as expected, this would cause prime rate to increase, leading to higher monthly payments for many of those with variable-rate mortgages.  

But with variable rates still near their all-time lows, Edge Analytics reports that up to a third of mortgagors are opting for variable over fixed rates, despite the growing likelihood of rate increases.

Meanwhile, 5-year fixed mortgage rates can generally be found for about a percentage point more than the lowest variable rates.

Is that a reasonable premium to pay for five years of rate (and monthly mortgage payment) stability? Those with low risk tolerance would say so, especially with all signs pointing to higher variable rates in the coming years.  

If you’re unsure which product is best for you, call me to discuss this and any other recommendations based on your current situation.