Canada’s central bank is seeing core inflation slow, but borrowing costs aren’t. BMO warns that long-term Government of Canada (GoC) bond yields have just hit their highest level since 2010. BMO points to oil prices as the bond market’s immediate concern. That may be the spark, but Canada’s persistent demand for debt is the bigger structural pressure.
Canadian Long-Term Yields Surge To Highest Level Since 2010
Government bond yields serve as the benchmark rate, the base cost used for loans with similar terms. Other investors compete by paying a premium (spread) for risk and liquidity. Rising benchmark yields don’t just mean the public pays more on government debt. It means everyone pays more for all loans of similar terms.
That’s bad news considering we just got another sign that the age of low rates is over in Canada. “The 30-year GoC yield briefly popped above 4.05%, the highest since 2010,” warns BMO chief economist Douglas Porter. “For some context, from early-2015 until early-2022, that yield averaged just under 2%.”
Even finance experts are likely thinking, “That doesn’t matter. No one uses a 30-year loan in Canada.” That’s true, but the 5-year GoC bond yield is also just off a multi-year high. More importantly, these yields are rising while inflation falls. Investors are focused on a different headwind, and it’s screaming a much bigger warning.
Bank of Canada Sees Slower Core Inflation, But Yields Are Surging
Earlier this week, StatCan reported headline inflation surged to a 23-month high. But the Bank of Canada’s (BoC) preferred core inflation measures actually cooled. BMO notes CPI trim faded to just 2.0% annual growth in April, a 5-year low and slightly below the 3-year pre-pandemic average. Normally, that should support a rate-cut narrative, but it’s not. Long-term yields are climbing aggressively.
“Sustained upward pressure on oil prices appears to be the sole focus of bond markets,” warns Porter. The bank sees this as especially notable, as it’s arriving alongside a sustained drop in underlying inflation. “Yet, the bond market is more focused on the latest climb in oil prices.”
That explains the short-term market reaction. It doesn’t explain why Canada’s long-term borrowing costs are becoming structurally harder to compress.
Porter sees considerable slack in the economy, with limited housing activity. As a result, he sees core CPI moving lower in the coming months. Few people are concerned that the economy will overheat, but yields continue to rise. This is an important reminder that inflation isn’t the only driver of yields.
Canada’s Bets On Borrowed Growth Are Now A Structural Drag
BMO didn’t dive into the supply-side issue, but it’s worth recalling that credit is a market. It’s subject to supply and demand, similar to any other market-based investment. Investors aren’t just trying to match inflation, but they need to beat it. To do that, they balance risks like currency and, most importantly, liquidity. An excess supply of benchmark debt means offering higher yields to attract investors. The higher the benchmark yield, the higher the cost of borrowing for everyone.
Historically, Canada has received preferential treatment among global investors, meaning substantial bond demand. This helped create the cheap borrowing that most households have come to know and love. However, even with these low rates, a persistent binge of borrowing future growth has led to a big bill. Data from the PBO shows interest payments will consume 1 in 8 dollars of federal revenue. Canada has already spent 1 in 3 dollars of future revenue on just elderly benefits and interest.
Developers, landlords, REITs, small businesses, governments, your mortgage—they all compete for capital. There’s no free lunch. The public incurs both direct and indirect costs when policymakers tap credit. Those indirect costs include a higher benchmark yield, translating into higher borrowing costs. When the government borrows on behalf of a company, it’s not free—the cost is pushed onto other borrowers. Hopefully, public spending pays off in multiples soon. If it doesn’t, Canada just reinforced structural threats to growth that policymakers were warned about.
The biggest concern is the one no one wants to say out loud. Core inflation is falling because demand is weakening, while headline inflation expectations and borrowing costs are rising. The combination of weak growth and persistent headline inflation is better known as stagflation.
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