Will the Bank of Canada Cut Its Overnight Rate This Week?
Monday Morning Interest Rate Update for July 13, 2015
This week’s big question is whether the Bank of Canada (BoC) will cut its overnight rate when it meets on Wednesday. It’s a tough call for the BoC because there are plenty of compelling reasons both for and against lowering this key rate from its current 0.75% level.
As a reminder, lender prime rates, on which our variable-rate mortgages are priced, typically move in lockstep with the BoC’s overnight rate. Our fixed mortgage rates are priced on Government of Canada (GoC) bond yields, and while these are not directly correlated with the overnight rate, GoC bond yields do move in the same direction of the overnight rate over time. As such, if you’re keeping an eye on where mortgage rates are heading, the BoC’s overnight rate is the one to watch.
The consensus believes that the BoC will lower on Wednesday, and there are plenty of reasons why.
For starters, there are several areas of rising instability across the globe at the moment. The Greek debt saga has entered full-blown crisis mode (again), the Chinese stock market is doing cartwheels while the Chinese government has responded with heavy-handed counter measures that are being interpreted as panic-like, and a looming Puerto Rican debt default threatens unsuspecting investors, many of whom are U.S. pensioners who didn’t even know that the funds they rely on had invested in Puerto Rican bonds. Any and/or all of these hot spots could send out shock waves with the potential to destabilize other vulnerable economies, many of which are ill equipped to withstand another broadside at the moment, having already tapped out their emergency reserves fighting the economic slowdowns that they have been experiencing since 2008.
Closer to home, oil prices have plummeted once again after a brief rebound, and that’s not good news for Alberta, where we still haven’t seen anywhere near the brunt of the negative economic impacts that await. Last week’s employment data, for June, showed that our jobs momentum is slowing, with 6,400 jobs lost for the month, and more importantly, it confirmed that there was a pronounced slowdown in job creation between the first and second quarter (66,000 vs. 33,000).
When the BoC cut its overnight rate in January, it said that it was taking out “insurance” against the risks of negative shocks from sharply falling oil prices, and the Bank could easily make the case that more insurance is needed against the current backdrop of slowing domestic momentum and still-rising instability risks beyond our borders.
On the other hand, it is not clear that another BoC rate cut would actually give our economy the kind of insurance that it needs. If a rate drop fuelled more housing market demand and caused a renewed surge in household borrowing, it would exacerbate the potential for bubbles in both areas. The BoC has already called our household debt levels the most significant risk to our domestic economy, and another rate cut would only fuel a temporary rise in consumer spending, giving our economy a sugar-high type of stimulus that would do little to put it on a path toward sustainable recovery.
BoC Governor Poloz has repeatedly said that we need rising export demand to fuel increased business investment if we are going to create the kind of sustainable growth that will return our economy to long-term health. And while it’s true that another rate cut would be expected to weaken the Loonie, which would help make our exports more competitive over time, the most immediate impact will be rising import costs (in many cases for the inputs that our manufacturers need to make their products for export).
So if the BoC is looking to give the economy an immediate shot in the arm, a rate cut might not be the right medicine. The Loonie is already falling against the Greenback, which investors apparently now view as the ultimate safe-haven asset in these uncertain times, and if the value of the Loonie drops too quickly, a rate cut will do more harm than good.
The BoC must decide whether a rate cut is an appropriate type of insurance by weighing both the benefits and the risks. We’ll find out on Wednesday which way the BoC’s scales are tilted.
Five-year GoC bond yields fell by two basis points last week, closing at 0.80% on Friday. Five-year fixed-rate mortgages are offered in the 2.49% to 2.59% range and five-year fixed-rate pre-approvals are available at rates as low as 2.69%.
Five-year variable-rate mortgages are available in the prime minus 0.65% to prime minus 0.75% range depending on the terms and conditions that are important to you.
The Bottom Line: My guess is that the Bank will go against the consensus this week and hold its overnight rate steady for the time being, because I think another rate cut would be the wrong type of stimulus in the current environment, where a fiscal response seems more appropriate. Also, the Loonie is already weakening against the Greenback, which is the main reason I would be cutting rates, so that development is already underway. Stay tuned.