Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News
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Canada’s Consumer Price Index (CPI) has shown another drop in overall
inflation, to 0.5% in January. Over the same period, the U.S. CPI came in flat,
at 1.6%, for the most recent twelve months.
The latest U.S. and Canadian CPI data bolster my belief that the Bank of
Canada (BoC) is more likely to lower, rather than raise, its overnight rate as
its next move to maintain its medium-term inflation target of 2%.
That said, while I continue to believe that inflation will remain benign for
the foreseeable future, eventually, inevitably, it will rise in accordance with
the intentions of the U.S. Fed (more on that in a minute).
First, let’s look at how large deficits and high levels of government debt
have impacted our mortgage rates to date.
Much of the developed world is now mired in a mutually reinforcing cycle
where high government debt and deficits act as a drag on growth, which lowers
business and consumer confidence and with it, consumer demand. Low demand causes
disinflation and in such an environment, central banks lower their policy rates
to ward off the threat of deflation. They do this primarily to stimulate
spending and investment but also to lower the interest cost of financing their
governments’ deficits. If policy rates reach 0%, central banks like the U.S.
Federal Reserve then resort to unconventional methods, like quantitative easing,
to inject further liquidity into their economies. This allows all debt levels to
increase still further. It’s like a drug dose to an addict - it helps in the
short term but just makes the long term more difficult.
At a very basic level, bloated government debt and deficit levels have fueled
today’s low-interest-rate environment. Here’s how this feedback loop works:
The current ultra-low interest-rate cycle in the U.S. and Canada will
eventually end in one of three ways:
Canada has a small, open economy that is highly integrated with the U.S. so
we will inevitably import this U.S. inflation when it rears its head. History
has taught us what will happen next, the only real question is one of
timing.
Five-year Government of Canada bond yields were eight basis points lower for
the week, closing at 1.40% on Friday. Any short-term upward pressure on bond
yields (and therefore mortgage rates) has now been reversed as evidence of our
continued economic slowing continues to mount. Five-year fixed-mortgage rates
are once again widely available at sub-3% rates.
Variable-rate mortgages are attracting increased rate competition among
lenders and as the prospect of a possible BoC rate cut increases, I expect
borrower interest in this option to continue to increase.
The bottom line: Today’s high government debt and deficit levels have
helped fuel today’s ultra-low interest-rate environment. While it will never
acknowledge this publicly, the U.S. Federal Reserve’s long-term solution will
almost certainly be to inflate its way out of the debt. When this eventually
happens, we will see higher mortgage rates, but the latest CPI data tell us that
this development is still a ways off on the horizon. Rest assured that I’ll be
keeping my binoculars at the ready.
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