Dave Larock in Monday Interest Rate Update, Mortgages and Finance, Home Buying, Toronto Real Estate News Editor's Note: Dave's Monday Morning Interest Rate Update appears on Move Smartly weekly. Check back weekly for analysis that is always ahead of the pack.
All hail the falling Loonie!
Queue the Lone Ranger theme song…
It has been a tough last few months for the Canadian economy. We have seen our trade deficit rise to unsustainable levels, our employment market has continued its slow bleed, and Canadian consumers, whose resilient demand helped pull us through the worst of the Great Recession, appear increasingly tapped out.
These trends have been unfolding for some time, going as far back as when Mark Carney was the Bank of Canada (BoC) governor. His solution was to implore businesses to use their cash-rich balance sheets to invest in productivity enhancements and capacity expansion. To which they universally replied, “After you.”
There were other options for our policy makers but they have been repeatedly ruled out, and for good reasons.
Lowering interest rates to stimulate demand would push our already record-high household-borrowing levels to new heights and create a credit bubble that could threaten the stability of our financial system. Printing money would undermine our hard-won monetary policy credentials, with no guarantee of success. Throwing more fiscal stimulus at our slow growth problem might have created some incremental short-term relief, but the benefits of this type of stimulus usually prove transitory and the cost would have expanded our budget deficit (which politicians can be especially wary of in election years).
Throughout the end of BoC Governor Carney’s tenure, the Loonie strengthened. This heaped further suffering on our export manufacturers who were already tightening their belts in response to reduced U.S. demand. Governor Carney acknowledged that the lofty Loonie wasn’t helping but argued that it was responsible for “only about 20 per cent of our poor export performance”. Instead, he continued to warn Canadians that rates would rise in the near future and this warning continued to prop up the Loonie.
Enter the silver tongued new BoC governor, Stephen Poloz. Using only his words, he has helped talk our exchange rate with the U.S. dollar down from near par when he started his term, to 90 cents as of last Friday. Granted, the U.S. Fed’s decision to taper its quantitative easing programs has helped strengthen the Greenback against all currencies, but Governor Poloz’s rhetorical shift in emphasis has also played a key role in the Loonie’s fall.
Instead of warning about higher rates, as former BoC Governor Carney used to do even in the face of expert scepticism, the new governor has shifted the BoC’s focus. Now he talks about “significant excess supply in our economy” and highlights our ultra-low inflation levels as his main concern. And rightly so. In theory at least, the BoC is supposed to care just as much about below-target inflation as it does about above-target inflation, and we have been well below the BoC’s 2 percent inflation target for over a year now.
In its latest Monetary Policy Report (MPR) , the Bank said that it doesn’t expect inflation to rise back to target for another two years and it acknowledged that “the downside risks to inflation have grown in importance”. As an added bonus, instead of concluding with Mr. Carney’s favourite warning about the imminent threat of higher rates, the BoC merely states that “the timing and direction of the next change to the policy rate will depend on how new information influences this balance of risks”. A neutral ‘wait and see’ stance if ever there was one, and much more appropriate (and realistic) for our current economic weather.
If you’re a currency trader, these words add up to a flashing “sell” sign over the Loonie. (Picture BoC governor Poloz smiling in agreement.)
As the BoC and Governor Poloz use their rhetoric to stick handle the Loonie down, mortgage borrowers benefit from what is the best possible cure for our current economic malaise. The cheaper Loonie gives a much needed shot-in-the-arm to our export manufacturers at the same time that U.S. demand is increasing. And this happens without increasing our federal government budget deficit or turning on our printing presses.
Granted, a cheaper Loonie means that the cost of imports will rise, but no solution comes without cost and in the grand scheme of things, that’s a price worth paying today. In a report published last week, David Rosenberg estimated that the economic impact from the recent fall in the Loonie was equivalent to a 100 basis point rate cut by the BoC. And unlike a BoC rate cut, the cheaper Loonie isn’t going to trigger a rise in household borrowing levels that Mr. Flaherty has to worry about.
Not every country can access such a solution so easily. Currency devaluation is a beggar-thy-neighbour policy whereby increased demand for one country’s exports comes at the expense of decreased demand for another’s. When the currencies of larger economies fall, other large nations respond by trying to devalue their currencies to lessen the former’s newfound competitive advantage. The currency wars being fought between Japan and South Korea offer but one recent example of this.
In our case, however, we benefit from being a small, open-market economy with a giant main trading partner. While a cheaper Loonie creates a powerful domestic stimulus for our comparatively small economy, the related negative impact that is created south of the border is dispersed across their much larger economic base.
Five-year Government of Canada bond yields fell another six basis points last week, closing at 1.64% on Friday. Lenders are continuing to drop their five-year fixed rates in response and it looks like spring-mortgage market competition may arrive early for mortgage borrowers.
Five-year variable-rate mortgage discounts also fell last week, with lenders now offering solutions in the prime minus 0.60% range (which works out to 2.40% using today’s prime rate of 3.00%). Even deeper discounting is available to borrowers who are willing to accept more limited terms and conditions.
The Bottom Line: The falling Loonie is good news for Canadian mortgage borrowers and home owners. It is true that a more competitive Loonie that helps our economy grow will contribute to a rise in mortgage rates over time, but that day still appears to be some ways off. In the meantime, if a stronger economy leads to higher employment and income levels, Canadians will be better able to afford house prices today, and higher borrowing costs when they eventually arrive.
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
