David Larock in Mortgages and Finance, Home Buying, Toronto Real Estate News
Last Friday Statistics Canada released its latest Consumer
Price Index (CPI) and it showed prices increasing by an average of 1.2% over
the most recent twelve months.
This was good news for anyone keeping an eye on mortgage rates because the
CPI is the single most important data point used by the Bank of Canada (BoC)
when setting its monetary policy.
If the Bank is worried that inflation is too high it will raise its overnight
rate, which is essentially the benchmark rate upon which all other Canadian
interest rates are set (either directly, in the case of variable rates, or
indirectly, in the case of fixed rates).
In simple cause-and-effect terms, when the BoC raises its overnight rate it
increases the cost of borrowing which lowers overall demand, and lower overall
demand then causes inflation pressures to ease (over time). Lowering rates
causes the opposite effects.
For those who are new to the mortgage-rate watching game, here is a general
overview of what the BoC is looking for in the CPI data (taken from the BoC’s October
Monetary Policy Report):
- The BoC’s primary mandate is “to promote the economic and financial
well-being of Canadians”, specifically by “keeping inflation low, stable and
- The Bank uses its monetary policy tools to keep inflation at a target rate
of 2%, but it will accept short-term fluctuations in the rate of inflation
within a “control range” of 1 to 3%.
- The BoC’s “inflation-targeting approach is symmetric, which means that the
Bank is equally concerned about inflation rising above or falling below the 2
per cent target”.
Now let’s look at the three key takeaways from the latest CPI report:
- Overall inflation came in at 1.2% for the third straight month while core
inflation, which is a subset of overall CPI that strips out more volatile inputs
like food and energy, came in at 1.3%.
- The category with the biggest price increase for the month was food while
most energy prices also continued their recent climb. The only categories with
price decreases were clothing and footwear.
- While the BoC has consistently lowered its inflation forecasts of late, last
month the Bank was still calling for inflation in the 1.5% to 1.6% range for the
fourth quarter of 2012.
Here is why I think the three points listed above are noteworthy:
- While the BoC has warned Canadians that it would raise rates faster than
most were expecting, CPI reports like the one just released make that highly
unlikely. Remember the BoC’s statement about its inflation targeting being
“symmetric” that I listed above in the overview of the BoC’s mandate? If the
Bank really is “equally concerned about inflation rising or falling below the 2
per cent target” as it says, then under the current circumstances it should be
much more focused on the risks of deflation than on any imminent threat of
accelerating inflation. Put another way, if the BoC were to raise its overnight
rate in the current environment, that would slow inflation even further and risk
pushing the CPI beyond the bottom of the Bank’s “control range” altogether.
- As I wrote in last
week’s update, if you have to spend more of your income on the basic items
that you need for survival (like food and fuel), you will have less money
available to spend on discretionary items that come from highly sensitive
sectors of the economy that are important for job creation and economic growth
(like, in the case of the October CPI report, clothing and footwear). The data
in the latest CPI report provide evidence of this divergence in pricing momentum
between basic and discretionary items.
- Even after consistently lowering its inflation forecasts, the BoC still
appears to me to be over-estimating future inflation (for example, last month
the Bank lowered its inflation estimate for Q4, 2012 to a range of between 1.5%
to 1.6% and that already seems too high). If the Bank is over-estimating our
economy’s rate of inflation then it follows that any associated forecasts, such
as those relating to the timing of future rate increases, would also need to be
Five-year GoC bond yields were eight basis points higher for the week,
closing at 1.37% on Friday. This had no immediate impact on five-year
fixed-mortgage rates, which are still widely available in the sub-3.00%
Variable-rate discounting is suddenly becoming more competitive as several
lenders moved their five-year variable rates lower last week. None of them are
yet within range of my best available variable-rate discount of prime minus
0.40% (which results in a 2.60% rate based on today’s prime rate), but this is
still an encouraging trend.
The bottom line: Add the latest CPI report to the substantial list
of reasons that the BoC is not expected to raise its overnight rate any time
soon, despite BoC Governor Mark Carney’s consistent warnings to the
To borrow a quote from Ralph Waldo Emerson: “What you do speaks so loud that
I cannot hear what you say.”
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