Last week was filled with good news for variable-rate mortgage borrowers.
The Bank of Canada (BoC) met last Wednesday and, as expected, left its target overnight rate unchanged. More surprisingly though, the Bank also eliminated its oft-repeated warning about near-term rate increases. Here is the exact wording from the announcement:
While some modest withdrawal of monetary policy stimulus will likely be required over time, consistent with achieving a 2 percent inflation target, the more muted inflation outlook and the beginnings of a more constructive evolution of the imbalances in the housing sector suggest that the timing of any such withdrawal is less imminent than previously anticipated.
The first notable wording change was the BoC’s “more muted inflation outlook”, which was supported by the December Consumer Price Index (CPI), released by Statistics Canada last Friday. The report showed overall inflation of only 0.80% over the most recent twelve months, along with core inflation of 1.10% over the same period. (Reminder: core inflation strips out the more volatile inputs to the CPI like food and energy prices.)
Our inflation rates have fallen steadily over the past year and a half and are among the lowest in the world. If they remain at current levels, the BoC will have to think seriously about lowering its overnight rate, not raising it, to achieve a two percent inflation target over the medium term.
Sound crazy? Let’s look at the other key wording change in the BoC’s latest statement – the “more constructive evolution of the imbalances in the housing sector”.
Our borrowing has slowed sharply of late and household credit is now expanding at a rate of only 3%, the lowest level seen since 1999. If household credit growth, which BoC Governor Mark Carney has repeatedly called the “greatest threat to our domestic economy”, continues to stabilize, the BoC’s interest-rate policy should align more closely with the actual economic data going forward.
I say this because I have long maintained that the Bank’s repeated warnings to Canadians about imminent rate increases have not actually been supported by economic data, domestic or otherwise, for some time. In fact, many analysts have long speculated that the BoC was using its higher-rate warning as a kind of moral suasion to persuade Canadians to slow their borrowing (a tactic that I would argue had little meaningful impact).
Even if you look at the BoC’s own economic forecasts, which were just updated in the latest Monetary Policy Report (MPR) that was released last week, there is plenty to suggest that the next move in the overnight rate could just as easily be down as up:
- The BoC cut its forecast for Canadian GDP growth from 2.40% to 2.00% in 2013. (Note: the Bank upgraded our GDP growth forecast for 2014 from 2.40% to 2.70% but didn’t support this optimistic revision with a detailed explanation. And it doesn’t jibe with any of the Bank’s projections for other countries in 2014, as you will see below). The Bank now also expects our output gap (the gap between our actual output and our maximum potential output) to disappear in the second half of 2014, instead of by the end of 2013, as forecasted in the October MPR.
- The BoC cut its forecast for U.S. GDP growth from 2.30% to 2.10% in 2013 and from 3.20% to 3.10% in 2014. The Bank now estimates that “fiscal consolidation will exert a significant drag on U.S. economic growth … [and this] will subtract roughly 1.5 percentage points from growth in both 2013 and 2014.”
- The BoC cut its euro-zone GDP growth forecast from 0.40% to -0.30% in 2013 and from 1.00% to 0.80% in 2014. The Bank now believes that “the economic recovery will be slower than originally thought, in part because fiscal austerity measures and tight credit conditions are taking a greater-than-expected toll on economic activity”.
- The BoC takes note of China’s recent economic rebound but also points out that “other economic activity has slowed further in other major emerging economies.”
- On an overall basis, the report states that while “global tail risks have diminished [meaning the risk of a systemic shock to the global financial system that could be caused by an event like a sovereign debt default], the global outlook is slightly weaker than projected in October”. In other words, the global economic momentum arrow is pointing down across the board.
Government of Canada (GoC) five-year bond yields were one basis point lower for the week, closing at 1.46% on Friday. Five-year GoC bonds remain locked in a range between 1.35% and 1.50%, with market five-year fixed rates fluctuating between 2.99% and 3.04%. As always, borrowers who know where to look can find mortgage planners offering anywhere from five to ten basis points off of those rates, depending on the terms and conditions (some of which are quite important).
Variable-rate discounts are available in the prime minus 0.40% range (which works out to 2.60% using today’s prime rate). While five-year variable rates only offer a small saving over their equivalent five-year fixed rates, last week’s BoC announcements provided further reassurance that this saving should remain in place for the foreseeable future.
The bottom line: I have long argued that the BoC’s warnings about near-term higher rates would not come to fruition and the Bank’s latest revisions to its interest-rate guidance confirm this view. With that question now put to rest I don’t think it’s crazy to wonder whether the next move in the overnight rate, when it eventually does come, has as much chance of being a decrease as an increase. (And that’s especially true if the BoC’s latest international GDP growth forecasts are on the money.)David Larock is an independent full-time mortgage broker and industry insider. If you are purchasing, refinancing or renewing your mortgage, contact Dave or apply for a Mortgage Check-up to obtain the best available rates and terms.