Monday Morning Interest Rate Update (July 23, 2012)

David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News

Rate Sheet (July 23, 2012)The Bank of Canada (BoC) left its overnight policy rate unchanged last week as expected. (Reminder: variable-rate mortgages are based on the BoC’s overnight rate).

While that widely anticipated news was met with a collective market yawn, the BoC also released its latest Monetary Policy Quarterly Report which is of great interest (pun intended) to anyone keeping an eye on where mortgage rates may be headed. The report gives us the BoC’s view of the main upside and downside risks to our economy, along with detailed insights into all of the factors that influence our mortgage rates.

The latest report carried more cautious overtones than the preceding April version (which I could not resist critiqueing as being far too optimistic at the time).

Here are my key takeaways from the July report:

  • The BoC thinks that “the prospects for global economic growth have weakened since the April Monetary Policy Report”.
  • In the euro zone “the adverse feedback loop between weakening economic activity and sovereign and banking sector vulnerabilities has intensified, rendering the task of fiscal consolidation even more challenging”. Put another way, slowing economic growth is making it harder to reign in market-fear-inducing debt levels, and these two factors are mutually reinforcing.
  • The BoC now believes that the euro area will begin to recover in early 2013 (as opposed to the second half of 2012 as stated in the April report) largely because “the worsening economic situation in the peripheral economies has begun to spread to the previously resilient core countries”. Remember that the peripheral economies represent key export markets for the core countries - this dynamic will intertwine their fates over the longer term.
  • Increasing investor demand for safe-haven assets has pushed bond yields in most major advanced economies to record lows at the same time as bond yields are spiking in imperiled countries like Spain and Italy. The spreads between what investors will pay for sovereign debt in the haves and have-not countries have widened to record levels.
  • The report reiterates that “[U.S.] monetary policy is expected to remain highly accommodative throughout the projection horizon” and that economic conditions in the U.S.will “warrant exceptionally low levels … at least through late 2014”. There is deep integration between the U.S.and Canadian economies and that increases the impact that interest-rate differences have on our exchange rates. As such, the BoC overnight rate will continue to be range bound until the U.S. Fed policy rate eventually rises. (BoC Governor Carney disputes this, but I hold it to be true nonetheless.)
  • “Recent data suggest that economic activity in many emerging-market economies, most notably China, India and Brazil, has slowed markedly … While a slowdown was expected, its extent has surprised on the downside”.
  • The BoC expects that Canada’s output gap to close in the latter half of 2013, and will therefore take “somewhat longer than previously anticipated”. (As a reminder, the “output gap” refers to the difference between our economy’s actual output and its maximum potential output.) This is important because when the BoC governor warned in the spring that mortgage rates would rise faster than most were expecting, he cited our economy’s closing output gap as one of his three key reasons.
  • Total CPI inflation is expected “to remain noticeably below the 2 per cent target over the coming year, before returning to target around mid-2013.” If that holds true, there will be no need to raise interest rates in an environment of under-target inflation. (Side note: the latest CPI for the twelve-month period ending in June was released latest Friday and came in at 1.5 per cent.)
  • The BoC now expects our overall GDP growth “to increase slightly from 2.1 per cent in 2012 to 2.3 per cent in 2013 and 2.5 per cent in 2014” and the Bank acknowledges that “[this] outlook for growth is weaker over the near term than in the April Report”.

It was noteworthy, although not entirely surprising given the raft of economic data to support the BoC’s more cautious overall view, that the BoC’s accompanying commentary did not include warnings about mortgage rates rising faster than expected this time around. Many interest-rate watchers speculated that the April warning was really just an attempt to ‘talk the market down’ and thus discourage people from borrowing more.

This belief was rooted in Governor Carney’s repeated warnings that rising household borrowing levels present the greatest risk to our domestic economy. One wonders if the recent changes made by federal finance minister Jim Flaherty to our high-ratio mortgage-insurance guidelines along with early signs of slowing housing markets across the country had more to do with Governor Carney’s omission this time around than any changes in the broader economic data.

Five-year Government of Canada (GoC) bond yields were down 3 basis points for the week, closing at 1.15 per cent on Friday. The popularity of GoC bonds as a safe harbour in stormy economic weather continues to increase and the most recent evidence was last week’s news that foreign investors bought $14.4 billion of GoC bills and bonds in May (the second highest total on record). When other forms of investment are included (equities and fixed-income securities) the May total jumps to $26.1 billion, which was a record high. Fixed-rate mortgage borrowers continue to benefit from this situation with five-year terms still widely available in the 3 per cent range.

Meanwhile, variable-rate mortgage discounts are still miniscule and, in my opinion, they do not justify taking on floating-rate risk when compared to their equivalent fixed-rate alternatives. That said, rates that are fixed for only a short term can be an attractive option for borrowers looking to capitalize on the interest-cost savings offered at the short end of the interest-rate curve. (Rob McLister wrote a good article that outlines the pros and cons of using this approach.)

The bottom line: The BoC’s latest monetary report bolsters my long-standing view that our mortgage rates will probably be on hold for the foreseeable future.

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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