Dave Larock in Monday Interest Rate Update, Mortgages and Finances, Home Buying
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The Bank of Canada (BoC) left its overnight rate unchanged last Wednesday, as was universally expected.
The BoC also released its latest Monetary Policy Report (MPR), which I read with great interest because it provides us with the Bank’s views on the state of our economy and includes projections for where it sees both foreign and domestic economic momentum headed over the next several years.
Here are five highlights on the state of the Canadian economy from the latest MPR:
- The Bank left its forecast for Canadian GDP growth largely unchanged from its last MPR, with a few small tweaks. It is now calling for slightly weaker growth in the first half of 2015 and slightly stronger growth in the second half. The BoC further estimates that our economy will revert to a long-term potential growth rate of 2% by 2016.
- The Bank acknowledges that exports “have been gaining traction” but that “investment remains weak”. The BoC has repeatedly said that any healthy Canadian economic momentum will have to start with export-led growth which will eventually lead to increased business investment in productivity enhancements and expansion. In the latest MPR, the Bank said that business investment actually contracted for the third consecutive quarter in Q3, 2014, and reiterated its belief that this trend won’t change until businesses become more confident that today’s recovery in export demand is sustainable.
- The Bank pushed out its forecast for when our economy will return to full capacity from “around mid-2016” in the July MPR to “the second half of 2016” in its October MPR. This is an important milestone for mortgage borrowers because it is expected to be the point at which the BoC starts to raise its overnight rate, on which our variable mortgage rates are priced.
- The Bank believes that the drop in our unemployment rate “may have overstated the improvement in labour markets”. It notes that over the past year we have seen an “elevated portion of involuntary part-time workers (roughly 930,000 on average over the past year)”, that our participation rate has fallen “by roughly double what demographic shifts would suggest”, that we have seen an increase in the average duration of unemployment, and that wage growth has been weak. All of these factors “point to the persistence of [a] significant excess supply” of labour.
- The Bank notes that both core inflation and total inflation, as measured by the Consumer Price Index (CPI), are now close to its target rate of 2%, but it continues to attribute this rise to “exchange rate pass-through and other sector-specific factors”. For example, it estimates that the cheaper Loonie has added between 0.1% and 0.3% to core CPI inflation and between 0.3% and .05% to total CPI inflation, but it expects these impacts to dissipate naturally by mid-2016. The Bank believes that “excess capacity in the economy and heightened competition in the retail sector” will exert more persistent downward pressure on inflation over time, to the tune of about 0.5%.
Here were some other key points of note:
- The Bank said that it would stop offering forward interest-rate guidance for the time being. This makes sense at a time when central bank policies have come to dominate all other market forces. Instead of merely providing guidance, these key phrases now have the potential to fuel rampant ‘low-rates forever’ speculation or to trigger market-disrupting bond-yield surges. The risks of offering forward guidance today simply outweigh the rewards.
- The Bank forecast a weaker trajectory for global growth, but more interestingly, it seemed to offer far less of an assessment on the state of the rest of the world’s largest economies. Perhaps this is a reflection of the uncertain times we live in, or perhaps of a more humble BoC Governor who is less sure of what the future will hold and who would rather focus his crystal ball on our domestic economy, which is the one he knows best.
- At the end of its report the Bank listed the five most important risks to its inflation outlook as per standard, and by my count, four of them were downside risks while only one was an upside risk. They were: Stronger U.S. private demand (upside risk), further disappointment in global growth (downside risk), lower oil prices (downside risk), weaker Canadian exports and business investment (downside risk), and stronger household spending in Canada (although a short-term upside risk if it fuels higher demand, the Bank expressed more worry about the downside risk of higher spending if a short-term rise in demand eventually leads to a disorderly unwinding of imbalances).
Setting monetary policy is an especially difficult challenge because central bankers must anticipate how decisions they make today will influence future economic outcomes that are also affected by a wide range of other factors beyond their control. This task is made even more challenging today because central banks in so many of the world’s largest economies are engaging in unconventional monetary policies, and on an unprecedented scale. BoC Governor Poloz starts the latest MPR with an insightful quote to describe how he approaches this monumental task: “For the policy practitioner, uncertainty is not abstract, it is a daily preoccupation. Uncertainty, and the policy errors it can foster, must not only be embedded in our decision-making processes ex ante, they must be worn like an ill-fitting suit ex post—that is, with humility.” His words make me think we’ve got the right person for the job.
Five-year GoC bond yields rose eight basis points last week, closing at 1.50% on Friday. Five-year fixed-rate mortgages remain in the 2.79% to 2.89% range, and five-year fixed-rate pre-approvals are offered at 2.99%.
Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.80% range, depending on the terms and conditions that are important to you.
The Bottom Line: The market reacted to the combination of the BoC’s latest MPR and its accompanying commentary as if the Bank had adopted a slightly more hawkish overall view. But I place more importance on the carefully worded report itself, and for the reasons outlined above, I interpreted the latest MPR as being as cautious as ever. Nuances aside, it still appears likely that the BoC’s next rate increase remains well off on the horizon.
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, Move Smartly, and on his own blog: integratedmortgageplanners.com/blog Email Dave
