For years, a major worry hanging over the Canadian economy has been the potential fallout from the “mortgage renewal cliff,” where homeowners faced significantly higher payments as their old, low-rate mortgages came up for renewal. While this challenge remains for some, recent developments suggest the immediate risk from mortgage renewals is becoming more manageable. The focus for economists and investors is now shifting to a different, potentially more significant threat: weakening in the labor market.
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Key takeaways:
- Bank of Canada interest rate cuts are beginning to alleviate the pressure of mortgage renewals.
- While some homeowners still face payment increases, the overall economic impact from mortgages is forecast to be less severe than previously feared.
- Growing signs of weakness in Canada’s job market are raising new concerns for household income and economic stability.
Mortgage Renewal Risks Appear More Manageable
The Bank of Canada (BoC) has started cutting interest rates, having reduced the benchmark rate by 75 basis points so far. This easing cycle is directly impacting borrowing costs. Yields on government bonds, which heavily influence fixed mortgage rates, have fallen. Specifically, five-year government bond yields, key for five-year fixed mortgages, and two-year yields, important for one- to three-year mortgages, are now below levels seen two years ago for shorter terms.
This means a substantial number of homeowners with one- to three-year mortgages may renew at lower rates than their current ones. Variable-rate mortgage holders are already benefiting from lower payments (for variable-payment types) or seeing more of their payment go towards principal (for fixed-payment types).
Payments will still likely increase notably for many holding four- or five-year fixed-rate mortgages as they renew at today’s higher rates compared to several years ago. These individual household challenges are real and should not be overlooked. However, the BoC’s rate cuts have made these increases smaller than they otherwise would have been. Our analysis suggests the net effect will increase total mortgage payments across the economy in 2025 by approximately 0.1% of total household disposable income – a significant amount in absolute terms, but a modest drag on the broader economy.
Chart illustrating how Bank of Canada rate cuts are mitigating mortgage payment increases for different mortgage terms in Canada.
Moreover, Canadian homeowners generally possess significant equity in their homes due to high home prices. This provides options for borrowers facing payment stress, such as refinancing with an extended amortization period to lower monthly costs if needed. This financial flexibility acts as an important buffer.
Focus Shifts to Labor Market Weakness
While higher mortgage payments strain household budgets, a weakening labor market can have an even more widespread impact on income and spending power. A typical one percentage point rise in the unemployment rate can lower household disposable income across the economy by roughly 0.5%.
Canada’s unemployment rate has been steadily climbing since reaching a low of 5% in mid-2022. Our current forecast anticipates this trend will continue, with the rate potentially reaching 7% by early 2025. This represents a substantial increase and would push the unemployment rate more than a percentage point above its pre-pandemic average. However, there are signs that deterioration could accelerate beyond this forecast.
Chart showing the trajectory of Canada's unemployment rate since mid-2022, highlighting the recent increase.
The total number of job openings available in the Canadian economy has fallen significantly, sitting 25% lower than a year ago. Initially, this decline wasn’t a major concern because job vacancies outnumbered available workers. The labor market was tight. That dynamic has now fundamentally shifted. The unemployment rate is now higher than pre-pandemic levels, and the job vacancy rate has fallen below the number of people actively seeking work.
Any further reduction in hiring demand would amplify the risk of the unemployment rate rising faster and higher than currently anticipated. This potential weakening in employment and wage growth poses a more significant threat to overall household income and the pace of Canadian economic growth than the expected impact from mortgage renewals alone.
What’s Next?
While the specter of a severe “mortgage cliff” recession seems less likely thanks to central bank actions, the Canadian economy is not out of the woods. The focus of concern has shifted decisively towards the labor market. Economists and policymakers will be closely watching upcoming jobs data for signs of accelerating weakness. The interplay between the pace of Bank of Canada rate cuts and the health of the job market will be crucial in shaping the economic trajectory through 2025.
