Dave Larock in Interest Rate Update, Mortgages and Finances
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Our economic data haven’t been very encouraging of late and that has caused many of the borrowers I speak with on a daily basis to speculate about whether our variable mortgage rates may be headed lower. While this is a reasonable view to hold under normal circumstances, in today’s post I’ll explain why I don’t think it will happen any time soon.
To briefly set the stage, our GDP growth rate hovers between 0% and 1%, our economy isn’t producing enough jobs to keep pace with the natural rise in our working-age population, and our average income growth is barely keeping pace with overall inflation growth, benign as it is.
Against this backdrop, the Bank of Canada (BoC) would normally be expected to drop its policy rate in an effort to stimulate economic growth, and lenders would quickly pass on that additional saving by lowering their prime rates, which our variable-rate mortgages are priced on. But today we live in anything but normal times, and if you choose a variable-rate mortgage with the expectation of future rate cuts, I think you will be disappointed.
To expand on this view, let’s look at the two key events that must both take place if variable mortgage rates are to fall from today’s levels.
Step one: The BoC must drop its overnight rate.
Here are three reasons why I think it won’t:
In summary, additional BoC rate cuts are far more likely to exacerbate high household debt levels than to start encouraging businesses to invest more productively, and they may even spook markets. For those reasons, I don’t think the Bank is in any hurry to ease its monetary policy further, despite rising pressure to “do something” in the face of our deteriorating economic data.
Unless, of course, another central bank forces the BoC’s hand.
If the U.S. Federal Reserve were to drop its policy rate first, the BoC would need to either match the Fed’s rate cut or risk a sharp appreciation of the Loonie which would then threaten our still nascent export recovery. While the recent strength in the U.S. economic data might lead you to believe that a Fed rate cut is unlikely, history suggests otherwise. Prominent economist David Rosenberg recently observed that whenever the Fed has paused for more than six months after hiking its policy rate, as it has now done, its next rate move has always been a cut.
So now let’s assume that the Fed drops and the BoC matches. If that were to happen, Canadian variable-rate borrowers would still only be halfway toward lower rates.
Step Two: If the BoC drops its overnight rate, Canadian lenders need to pass on the additional discount to variable-rate borrowers.
Here are three reasons why I think they won’t:
Five-year Government of Canada bond yields fell one basis point last week, closing at 0.60% on Friday. Five-year fixed-rate mortgages are available in the 2.39% to 2.49% range, depending on the terms and conditions that are important to you, and five-year fixed-rate pre-approvals are offered at about 2.54%.
Five-year variable-rate mortgages are available in the prime minus 0.40% to prime minus 0.50% range, which translates into rates of 2.20% to 2.30% using today’s prime rate of 2.70%.
The Bottom Line: When our economic data soften, it normally leads to speculation that the BoC will drop its overnight rate, and in so doing, trigger a rate cut for variable-rate borrowers. But these are not normal times, and if you are considering a variable-rate mortgage today because you believe that there are rate cuts on the horizon, I would advise you to think twice. To be clear, I don’t think either our fixed or variable rates will rise materially in the foreseeable future. I just wouldn’t be choosing a variable rate on the bet that it’s headed lower any time soon.
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