We are likely in for at least another year or so of low interest rates and strong real estate markets, assuming the inflation genie stays in the bottle.

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Mortgage Rates Will Determine Toronto Price Trends

Market Update

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06/03/21

Extreme volatility has buffeted the Toronto area real estate market over the past 15 months, ever since the initial Covid lockdowns last March. Despite the ups and downs, however, the market has been very strong overall. Since the beginning of 2021, prices for both houses and condos are up by more than 15%. While several factors have been instrumental, by far the most important factor is mortgage rates. Five year variable mortgages, for example, are available at under 1.5%, and likely to stay low for some time to come.

Let’s have a quick look at what is driving mortgage rates, and how rates might move over the next year or so.

First, you need to understand that fixed and variable mortgage rates are subject to different factors.

Variable Mortgage Rates

Variable mortgage rates are closely linked to the Bank of Canada’s Overnight Rate, which the BOC reviews 8 times per year. Changes in the Overnight rate are typically reflected very quickly in their variable mortgage rates. Our central bank has kept the overnight rate at 0.25% for more than one year, and has said that they are unlikely to increase it before the second half of 2022. In other words, variable mortgage rates will probably remain more or less where they are for another year or so.

Fixed Mortgage Rates

Fixed mortgage rates are a different story. Unlike variable rates, fixed rates are closely tied to bond yields, especially government bonds. The price of a bond is inversely proportional to market interest rates, that is, as interest rates go up, the value of an existing bond (with a fixed coupon rate) goes down. Central banks around the world (including Canada) have been keeping interest rates low by purchasing government bonds to bolster demand and thus keep bond prices up. (This is called Quantitative Easing, or QE.)

Inflation Fears

Many fear that this ‘money printing’ will mean persistent inflation, which would lead to higher interest rates. This has caused some downward pressure on bond prices and hence upward pressure on bond yields. So far, bond rates (and thus fixed mortgage rates) have not increased that much, and only about 1% above variable rates. If the gap continues to widen, it may compel the Bank of Canada to bring the bank rate more in line with ‘prevailing’ rates. This would cause higher variable rates and would almost certainly put a damper on the market.

Is the inflation we are now seeing temporary, or is it the start of of a larger trend? Among experts on the subject one can find roughly equal numbers that project increasing inflation versus decreasing inflation or outright deflation in the longer term. The outcome will determine whether fixed mortgage rates will continue to rise or will reach a peak and fall back over the coming months. In turn, this will have a huge impact on whether house and condo prices continue to rise or pull back later this year or in 2022.

Government of Canada bond prices tend to follow US Treasury prices very closely. This means that trends in the US bond market may well be our best indicator as to the direction of Canadian real estate prices.

My best guess? Our economy will not bounce back as quickly as many expect, and this will mean higher bond prices and lower fixed mortgage rates over the next year or so. So, I suspect we’ll see a continued uptrend in real estate prices through the rest of 2021 and into the first half of 2022, with perhaps some seasonal ups and downs along the way.

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Mortgage Rates Will Determine Toronto Price Trends

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