A Rate Cut Bonanza

The Bank of Canada (BoC) cut its policy rate by another 0.25% last week.

In its accompanying statement, the Bank assessed that tariff and trade uncertainty was “weighing heavily on economic activity” and noted that the upward pressure on its preferred measures of core inflation, which was evident earlier in the year, have dissipated.

The BoC now estimates that our “underlying inflation is running around 2 ½ percent”. While that is above its 2% target, the Bank expects that our federal government’s decision to remove most retaliatory tariffs on US imports “will mean less upward pressure on the prices of these goods going forward.”  

The combination of “a weaker economy and less upside risk to inflation” gave the BoC room to cut again, which it did to “better balance the risks.”

The Bank’s latest communications were squarely focused on downside risks ahead. While its path forward will remain data dependent, it certainly sounded to this blogger that more rate cuts are in store.

Bond-market investors currently put the odds of a BoC rate cut at its next meeting on Oct 29 at 50%.

The US Federal Reserve also reduced its policy rate by 0.25% last week, but not with quite the same conviction.

The Fed has a dual mandate to maintain price stability and to promote maximum employment. Right now those two objectives call for opposite monetary-policy responses.

Recent revisions to the US employment data have revealed a much weaker-than-expected labour market, which a rate cut might help by stimulating more consumer demand.

Conversely, the core US consumer price index (CPI), which is the Fed’s most closely watched gauge of US inflation, is currently 3.1% (and its target for this measure is 2%.)

US core CPI also increased by 0.35% month-over-month in August, which means it is accelerating further at the margin.

US bond-market investors have already pushed up longer-term US Treasury yields over concerns about the impact rampant fiscal spending is having on inflation.

If the Fed doesn’t adequately factor those concerns into its rate-cut plans, the long-end of the US Treasury curve will rise higher and blunt their stimulative impact. In fact, if Fed cuts cause longer-term US borrowing rates to rise, their overall impact could be net negative (because more US borrowing takes place at the longer end of the Treasury curve).

US Fed Chair Jerome Powell positioned the Fed’s latest policy-rate decision as a pre-emptive “risk-management cut” that wasn’t necessarily called for based solely on the current economic data. He went on to note that “the projections for growth this year and next actually ticked up just a little bit and inflation and unemployment didn't really move.”

Those comments were noteworthy, but they didn’t sway the expectation of US bond-market investors, who are now pricing in a 90% chance that the Fed will cut at each of its next two meetings in October and December.

The Latest on Mortgage Rates

Fixed Rates

Government of Canada (GoC) bond yields increased a little last week after the BoC and Fed announcements. That response, which may seem counter-intuitive, likely occurred for two main reasons:

1. The BoC’s rate cut had already been priced in by the market, and investors tend to buy the rumour and sell the fact.
2. GoC bond yields were pulled higher by rising US Treasury yields, which jumped higher when Fed Chair Powell’s comments weren’t deemed sufficiently dovish.

Simply put, the GoC bond yields, which our fixed mortgage rates are priced on, had already moved lower in anticipation of last Wednesday’s cut. If they both drop further from here, it will have to be for a different reason.

Variable Rates

Variable-rate borrowers had to wait for the BoC’s actual cut to see their borrowing costs reduced. Their rates will now drop by 0.25% in short order.

While a lot of ink will now be spilled in the lead up to the BoC’s next meeting as each new piece of key economic data is released, the exact timing of the next cut is less important than the overall direction of the BoC’s policy rate.

It currently stands at 2.50%, and I continue to expect that it will be reduced to at least 2.00% before the end of the Bank’s current rate-cut cycle.

By its own estimate, the BoC’s policy rate won’t be helping to stimulate our economy until it reaches 2%. It has reduced it to that level, or lower, over each of its past five rate-cut cycles stretching back more than twenty-five years.

Insider’s Tip for Borrowers

Did you know that borrowers who put down less than 20% of the purchase price of a property get the best rates?

If that doesn’t makes sense to you, it will after you read this post.

My Take on Today’s Most Popular Mortgage Options

Fixed rates are now offered at about their long-term average levels.

Right now, the best available three- and five-year fixed rates are both good options. If these rates remain roughly equal, I think five-year fixed-rate terms offer slightly better value.

I continue to believe that today’s variable mortgage rates will likely produce the lowest borrowing cost over their full term, and I expect the BoC to enact more rate cuts over the relatively near term.

Anyone choosing a variable rate should do so only if they can live with its inherent potential for volatility. Borrowers must also have the financial capacity to withstand higher costs (and, in some cases, higher payments) should my forecast prove incorrect.

Three Posts Every New Visitor to My Blog Should Read

This post provides a detailed comparison of the pros and cons of fixed- and variable-rate mortgages.

This post provides a detailed breakdown of the very different ways that lenders calculate their fixed-rate mortgage penalties. The amounts charged can vary significantly from lender to lender. A lower penalty can save borrowers thousands of dollars if rates drop.

This post provides a detailed summary of the key terms and conditions to pay attention to in your mortgage contract.

David Larock is an independent full-time mortgage broker and industry insider who works with Canadian borrowers from coast to coast. David's posts appear on Mondays on this blog, Move Smartly, and on his blog, Integrated Mortgage Planners/blog.

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