How Last Week’s Major Announcements Are Likely to Affect Canadian Mortgage Rates - Monday Interest Rate Update (June 9, 2014)

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.

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There were several noteworthy developments last week for anyone keeping an eye on Canadian mortgage rates. In today’s post, we’ll go around the horn to provide highlights from each.

The Bank of Canada’s Latest Policy Rate Announcement

  • The Bank of Canada (BoC) left its overnight rate unchanged, as expected.
  • The Bank reiterated its belief that the recent rise in our inflation rate, as measured by the Consumer Price Index (CPI) was, “largely due to the temporary effects of higher energy prices and exchange-rate pass through”.
  • The BoC continued to emphasize downside risks across the board. On Canada’s economic momentum: “Weighing recent higher inflation readings against slightly increased risks to economic growth leaves the downside risks to the inflation outlook as important as before.” On U.S. economic momentum: “… there could be slightly less underlying momentum than previously expected.” On global economic momentum: “… recent developments give slightly greater weight to downside risks.”

  • The Bank made four separate references to the weaker Canadian dollar in its relatively short statement. Its main messages were that the negative impacts of the weaker Loonie on inflation should be both minor and transitory, while the benefits of our cheaper currency were expected to strengthen foreign demand and improve corporate profits, especially in exchange rate sensitive sectors. The Bank reiterated its hope that higher profits would then lead to increased business investment activity in the coming quarters.
  • The BoC capped off its statement with a very neutral reference to the direction of its next interest-rate change being dependent on “how new information influences the balance of risks”.

The market interpreted this announcement as having a slight rate-drop bias, and I imagine this is exactly what the BoC intended. In a world where other central banks are using radical and unprecedented levels of balance sheet expansion to stimulate their economies (to little lasting benefit in most cases), if the BoC  needs to only utter a somewhat pessimistic economic view to push our currency lower, then so be it.

A cheaper currency gives our economy an effective boost with nowhere near the cost of the monetary-policy steroids that pollute other central bank balance sheets, so why not? This is an advantage of being a small, open economy that trades freely with giants who often react to each other’s exchange-rate fluctuations with currency-war accusations before responding with counter measures.

If we can talk our currency down with a little rhetoric that doesn’t produce a hostile reaction by our trading partners, I can hardly think of a better (and more cost effective way) to give our economy a boost.

The European Central Bank Launches New Monetary Easing Measures

Last Thursday the European Central Bank (ECB) launched several new monetary policy measures in an attempt to stimulate economic growth. Here is a breakdown of the steps the Bank took with an explanation of each:

  • The ECB cut its key refinancing rate from .25% to .15%. This is the rate that banks have to pay when they borrow money from the ECB, and it serves as the benchmark rate for other types of loans to consumers and businesses. This ten basis point rate drop is not expected to have much impact because the previous rate of .25% was already at a rock-bottom level, and it has been in place since early 2011.
  • The ECB cut the deposit rate, which it pays to banks for the funds they leave on deposit with it, to -0.1%. This is the first time that a major central bank has experimented with a negative deposit rate and it is controversial. The ECB may be betting that by creating a net cost for keeping funds idle it will force banks to lend out their reserves, but to me this is moral hazard writ large. By trying to force money back into the system, the ECB is in effect compelling lenders to lend. But if the ECB is successful in overpowering market forces, there is a danger that banks will lend more aggressively than they otherwise would, and should, thus tempting the natural law of unintended consequences. Many market watchers think that the ECB’s real intent was to use negative deposit rates as a way to devalue the euro. (For example, Denmark successfully used negative interest rates to reverse the appreciation of its currency in 2012.)
  • The ECB ended the policy of sterilizing its bond purchases. In May 2010 the ECB created a government bond purchase facility called the Securities Market Program (SMP), which allowed it to buy government bonds from Greece, Ireland, Portugal, Spain and Italy. The Bank did not want to print money to buy these bonds, as the U.S Federal Reserve has done, because doing so would increase the money supply and risk unleashing uncontrollable inflation. To mitigate this risk, and to gain German support for the program, the ECB agreed to ‘sterilize’ its bond purchases by offering banks interest-bearing deposits that were equal to the amount of government bonds the ECB held on its books. When the banks bought these interest-bearing deposits, the money used was held by the ECB and was effectively drained from circulation in the market. This was done on a weekly basis so by cancelling this program next week the ECB will essentially be monetizing those funds (roughly 175 billion euros) into the banking system. In essence, by cancelling the SMP the ECB is now engaging in full-blown quantitative easing (QE) and dropping any pretenses to the contrary.
  • The ECB has set up a new long-term refinancing operation that will provide 400 billion euros in cheap four-year loans to banks that will be targeted specifically towards small and medium-sized businesses.

The ECB’s measures were the widely anticipated response to the euro zone’s lower-than-expected growth and inflation data. While the ECB’s actions are a way for the Bank to provide economic stimulus, they were also intended to devalue the euro, which has remained at stubbornly high exchange-rate levels to the surprise of many. Unlike the Loonie, which as mentioned above can devalue against other currencies without provoking counter reactions, the euro is the currency for the world’s largest single market and devaluing it is far more complicated.

The ECB’s measures may work in the short run, but many experts believe that much more outright QE will ultimately be required. As another of the world’s major central banks appears set to sacrifice its balance sheet in an attempt to cure economic woes, remember that the BoC has not engaged in any QE since the start of the Great Recession. As the world braces for more rounds of QE and new forms of financial alchemy, I expect that we will see plenty of incremental demand for safe-haven assets like Government of Canada (GoC) bonds, and this should help keep our bond yields, and our mortgage rates, at ultra-low levels.

The Latest U.S. Employment Data

  • The U.S. economy added 217,000 new jobs in May, almost bang on the consensus estimate of 215,000. This is the first time in fifteen years that the U.S. economy has added 200,000+ new jobs for four straight months. Also of note, the latest job gains mean that the U.S. labour market has now recovered all of the nine million jobs that were lost since 2008.
  • The job recovery milestone provided little cause for celebration however, because those nine million new jobs were created while the working-age U.S. population grew by sixteen million over the same period. This explains why the U.S. participation rate, which measures the percentage of working-age Americans who are either employed or actively looking for work, remains stuck at 62.8%. This is the lowest the U.S. participation rate has been in thirty-six years.
  • Average U.S. earnings rose by 0.2% for the month, and they have risen by only 2.1% over the most recent twelve months. This means that U.S. incomes have barely kept pace with U.S. inflation, a by-product of the long-held concern that that higher paying jobs are being lost while lower paying jobs are being added in their place.

Those who believe that the U.S. economy has turned a corner point to increased consumer spending as one of the key signs of its improvement. But, as I have pointed out in past posts, this recent pick up in U.S. economic momentum appears to have been fueled more by increased borrowing than by rising incomes, and that will prove to be an unsustainable trend over the long run.

The Latest Canadian Employment Data

  • The Canadian economy added 25,800 new jobs last month, which was just about what the consensus was expecting. We have seen an extraordinary amount of volatility in the monthly employment data of late, and in such situations it is best to look to longer term trends to smooth out some of the ‘noise’. To that end, the Canadian economy has created a monthly average of 7,000 new jobs over the past twelve months, and an average of only 3,000 new jobs over the most recent six months. To put that in perspective, our economy needs to create about 20,000 new jobs each month just to keep pace with our population growth.
  • As has often been the case recently, the details in our latest employment data quickly took the shine out of May’s impressive-at-first-glance headline result. For example, our economy added 54,900 part-time jobs and lost 29,100 full-time jobs (on top of the 30,900 full-time jobs that were lost in April). Also, most of the jobs gains were in sectors that are known to be of the lower paying variety, such as education, accommodation & food services, agriculture and retail.
  • The goods-producing sector lost 9,500 jobs for the month, so we are still waiting for the cheaper Loonie to give a sustainable boost to our export manufacturers. The BoC had previously acknowledged that its hoped for currency-fueled boost to our manufacturing sector was ‘not in the numbers yet’ and a shrinking of available goods-producing jobs would imply that this is still the case.
  • Average hourly wages fell by 1.2% for the month, which marks the largest year-over-year drop since 1998. Worse still, we are now seeing wage growth decelerate at the same time that our inflation is spiking (albeit temporarily, according to the BoC). The confluence of these two trends does not paint an encouraging picture of our economy at the present time.

Five-year GoC bond yields rose by five basis points last week, closing at 1.58% on Friday. Five-year fixed-rate mortgages are offered in the 2.84% to 2.99% range and five-year fixed-rate pre-approvals are available at rates as low as 2.99%.

Five-year variable-rate mortgages are available in the prime minus 0.65% range, which works out to 2.35% using today’s prime rate of 3.00%. In fact, well-qualified borrowers who know where to look may even be able to do a little better than that.

The Bottom Line: The BoC has been clear that the Canadian economy needs an export-led rebound to snap out of its current malaise, and its careful choice of words has successfully devalued the Loonie to help in this regard. The ECB is not so lucky and has had to risk the integrity of its balance sheet in an attempt to achieve the same end. The combination of increased demand for harder-to-find, safe-haven assets like GoC bonds and a less-than-rosy Canadian economic outlook should conspire to keep our mortgage rates near today’s ultra-low levels 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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