“It’s tough to make predictions, especially about the future” - Yogi Berra.
Trying to predict the timing and direction of future mortgage-rate changes is like trying to guess how a jig saw puzzle will look when you can only see half of the pieces at any point in time and when the underlying (economic) picture itself is constantly being altered by a shifting landscape and competing forces.
The release of each new data point gives us another puzzle piece to fit into our evolving view, but some data are more meaningful and revealing than others. For example, last Monday we focused on the just-released October Consumer Price Index (CPI) and this is normally the single most important piece in the ongoing mortgage-rate forecast puzzle.
It showed inflation at 1.20%, or barely above the bottom of the Bank of Canada’s (BoC) “control range” of 1.00 to 3.00%. This was noteworthy because the number came in well below the BoC’s fourth quarter inflation forecast of 1.50 to 1.60%. If inflation proves to be more subdued than the BoC is expecting, it casts further doubt on its repeated warning that borrowing rates will rise faster than most Canadians are expecting.
While it is true that inflation is “normally” the most important data point that is used by the BoC when determining its monetary policy, in the current environment the Bank is actually placing more emphasis on our rate of economic growth.
This shift in policy first became apparent when the BoC recently started talking about “flexible inflation targeting”. This was the Bank’s fancy term for saying that it will allow inflation to rise above its 2.00% target rate (the mid-point of the Bank’s 1.00 to 3.00% control range mentioned above), if growth is weak and doing so would help our economy grow.
Federal Finance Minister Jim Flaherty also reinforced this shift in the BoC’s approach when he recently said that he was more concerned, quite frankly, about growth in the economy [than about inflation]”, after strategic discussions with BoC Governor Mark Carney in September.
Given this change of focus, our GDP data, which were updated by Statistics Canada last Friday, may now have overtaken inflation to become the most important piece of the mortgage-rate jig saw puzzle.
This clear trend toward slowing growth is especially significant because in its latest Monetary Policy Report the BoC predicted that our GDP growth would rebound to 2.50% in the fourth quarter, an estimate that went a long way to justifying the BoC’s aggressive interest-rate view and one that now appears to be wildly optimistic.
Beyond the headline number, the details in the latest GDP report also lend support to the view that a sharp growth rebound in our near future is highly unlikely. We saw a sharp drop in exports (the biggest drop in over three years) which didn’t come as a surprise given the lofty Loonie, but we did not see an offsetting rise in business investment from Canadian companies looking to improve their productivity, as we had grown accustomed to in recent quarters. In fact, business investment declined by 0.60% in the third quarter of this year, ending a streak of increased spending for this sub-category that began in the third quarter of 2009. Ongoing economic uncertainty is taking its toll.
On the flipside, the single biggest contributor to our GDP growth was a 3.80% year-over-year increase in consumer spending. That’s not much to hang our economic hat on because household disposable income is growing more slowly than inflation (0.80% vs. 1.20%) and the gap is being absorbed by a declining household savings rate (from 4.20% in the second quarter to 3.90% in the third quarter). Over the long run, either incomes have to rise more quickly or spending has to drop and, from my desk, the latter seems far more likely.
Five-year Government of Canada bond yields were eight basis points lower for the week, closing at 1.29% on Friday. Borrowers who know where to look can find a wide range of sub-3.00% fully featured five-year fixed-rate mortgages that come with excellent terms and conditions.
Variable-rate mortgages remain a viable alternative for borrowers who are willing to trade the stability of a medium-term fixed rate in exchange for the savings currently offered at the short end of the yield curve. (Variable-rate discounts are still offered in the prime minus 0.40% range, which using today’s prime rate works out to 2.60%.)
The bottom line: The BoC has maintained a hawkish view on the future direction of our borrowing rates for some time, despite a steady stream of economic data that seems to directly contradict this view. We will be interested to see if the Bank softens its interest-rate language tomorrow when it makes its next policy announcement, especially given that household borrowing rates (the BoC’s #1 domestic concern) appear to be moderating. Stay tuned.
David Larock is an independent mortgage planner and industry insider specializing in helping clients purchase, refinance or renew their mortgages. David's posts appear weekly on this blog (movesmartly.com) and on his own blog integratedmortgageplanners.com/blog). Email Dave