Monday Morning Interest Rate Update (December 3, 2012)

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

Mortgage Update Pic

“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

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
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

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.

The just-released GDP data showed that our economic growth rate was flat for
the month of September after shrinking by 0.10% in August. On a quarterly basis
so far in 2012, our GDP growth has gone from an average of 1.70% in the first
and second quarters to 0.60% in the just-completed third quarter (which was well
below the BoC’s latest Q3 forecast of 1.00%).

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

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 ( and on his own blog Email Dave

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