Monday Morning Interest Rate Update (January 16, 2012)

David Larock in Mortgages and Finance, Home Buying

Rate Sheet (Jan 16, 2012)The European Central Bank (ECB) made a bet in December that if they offered unlimited three-year loans to liquidity-starved European banks, those banks would then support ailing euro governments by buying up their bonds and creating enough demand to bring their spiraling bond yields down from the stratosphere. Specifically, they extended more than US$600 billion worth of these loans to 500 banks at a rate of 1% and hoped that the banks would use some of that money to buy-up sovereign debt with yields of 5% or more, locking in a handsome spread for their troubles.

The move was a controversial one, and it was a game changer. Consider that the ECB’s average loan duration was 10 weeks before the huge December auction and has now been blown out to 21 months; the ECB’s mandate has clearly shifted from providing short-term liquidity to acting as Europe’s lender-of-last-resort. Many of Europe’s more conservative stakeholders said that the ECB was doing an end run around treaties that were specifically designed to limit the central bank’s ability to buy sovereign debt. Meanwhile, market watchers questioned whether the banks would respond as expected, predicting that they would use the emergency loans to shore up their shaky balance sheets instead.

Over the short-term at least, the ECB’s big bet appears to be achieving the desired result. European bond yields were sharply lower last week and both Italy and Spain successfully issued new debt at significantly lower yields. That said, this encouraging trend was tempered by Friday’s news that Standard & Poor’s downgraded the credit ratings of nine European countries (most notably France) and by new data indicating that the German economy likely contracted in the last three months of 2011. Germany and France are supposed to act as counterbalances to Europe’s many struggling economies, so neither development is a trend in the right direction.    

Five-year Government of Canada (GoC) bond yields were basically flat last week, closing at 1.26% on Friday as investors continued to seek out safe-haven investments which are becoming harder to find at the same time that demand for them continues to grow. While steadily falling GoC bond yields have substantially increased our lenders’ profit margins over the past several months, fixed-mortgage rate drops have been slow in coming – until now.

Last week the Bank of Montreal announced a short-term promotion offering a five-year fixed-rate mortgage at 2.99% (the lowest five-year fixed rate ever offered by a major Canadian lender). The product comes with several restrictions, and the promotion is being offered for only two weeks, but it caught the market’s attention and other lenders have finally begun to lower various fixed rates in response. Let’s hope this trend continues – we have been saying that fixed rates have been due for a decrease for some time now.

Variable-rate mortgage discounts are holding steady, but with prime minus 0.20% among the best variable rates available, most borrowers are opting for the safety of the five-year fixed, especially now that the spread between fixed and variable is well under 0.5%.

The bottom line: The ECB had to take a more active role to help pull Europe back from the brink, and their loans have provided some welcome short-term relief to European bond markets. But a crisis caused by excessive credit isn’t likely to be solved by issuing more debt, even at dirt-cheap rates. This was like adding a few more decks to a wobbling house of cards. While Europe’s financial system is now relatively more stable, it is still fundamentally flawed, and the only real elixir, economic growth, remains in short supply.

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 ( and on his own blog Email Dave

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