Variable rates are still good
In a time characterized by widespread economic turmoil across the US and Europe, there was a certain comfort to be taken in the mundanity of the Bank of Canada’s (BoC) report today. As almost unanimously predicted, the BoC left overnight rates unchanged at 1%, meaning the prime rate stays pegged at 3% and the variable rate mortgage holders of Canada continue to prosper. However, there were some nods towards a rate increase approaching on the horizon. The quote of the day being the warning that monetary stimulus “will be withdrawn”, a statement whose severity is underscored by the omission of the word “eventually”, which was mentioned at the BoC’s May 31st meeting.
However, it is our contention that we are unlikely to see rate increases at the next meeting, in September. A far more likely target would be December at earliest or, more likely, early next year. This prediction comes with a backdrop of increasing pessimism concerning the US. It is our belief that the US policies for growth, characterized by strict austerity measures, could see the US plummet into an economic purgatory from which it may find it hard to escape. This would restrain the BoC from making any substantial rate hikes and, while an increase in rate is almost certainly just around the corner, a series of hikes may not be sustainable. When you add this to the increasing likelihood of Greece’s loan default and now the potential inclusion of Italy into the economic abyss, the case for dramatic rate hikes only erodes further.
While the Bank of Canada will likely act to stem core inflation, which it has highlighted as “slightly firmer than anticipated”, the prevailing consensus remains that this is being driven by “temporary factors”. The bottom line is that we think the 40% of Canadian home owners who are now in variable mortgages can rest assured that they’ve made the right option. Obviously if you’re not comfortable with the inherent risk associated with variable mortgages there’s always the fixed option and it’s rare to see fixed rates so low, so it’s a nice option to have.
If you should have any questions on anything you’ve read here or are interested in perhaps switching to a variable rate mortgage and would like some of our sound, unbiased mortgage advice then we suggest you give us a call today at 403-681-4376.
The case for using a broker has never been stronger, with more and more Canadians beginning to realize that savings associated with utilizing the services of a broker. We’ve included a link to this Bank of Canada report outlining the savings on “search costs” which brokers provide. They demonstrated that “over the full sample the average impact of a mortgage broker is to reduce rates by 17.5 basis points.” For all those mathematically limited soles like me, that means $1,670 of interest savings on a typical $200,000 mortgage over five years. Don’t be one of those people who let the comforts of a familiar bank name dissuade you from making the savings available to you. Call Mark Herman today!
Consumer Prime stays the same at 3% – but for how long?
Prime stayed at 3% today and as below rate hikes are coming as soon as we are past the recession for good. These super low rates are the tail end of the recession so take advantage of them while you can. Call to discuss what that means for you. 403-381-4376
Bank of Canada sees hikes on the horizon
Bank of Canada governor Mark Carney.
Photograph by: Reuters
OTTAWA — The Bank of Canada held its benchmark interest rate steady on Tuesday, as widely expected, as the global economy remained fragile amid debt problems in Europe and the United States.
But the central bank hinted higher borrowing costs could be coming sooner than later if the domestic economy maintains steady growth.
The bank’s lending rate has been at a near-historic low of one% since last September in an effort to spur economic growth following the downturn.
“To the extent that the expansion continues and the current material excess supply in the economy is gradually absorbed, some of the considerable monetary policy stimulus currently in place will be withdrawn,” the Bank of Canada said in its interest rate statement. “Such reduction would need to be carefully considered.”
Avery Shenfeld, chief economist at CIBC World Markets, “may be nudging the market into pricing greater odds of at least a modest dose of interest rate hikes before year end.”
“It dropped the word ‘eventually’ in reference to the need for rate hikes ahead, and while saying some of the pressure on core inflation is ‘temporary,’ it also attributed some to ‘more persistent strength in the prices of some services’.”
The Bank of Canada on Tuesday also revised its economic growth outlook for 2011 to 2.8%, down from the previous estimate of 2.9%. Left unchanged were growth forecasts for 2012, at 2.6%, and 2013, at 2.1%.
“Of course, the troubles abroad and challenges to net exports kept the bank from hiking as early as today, and it is still assuming a resolution of the eurozone debt issues,” Shenfeld said. “But signs of better growth in the U.S. and Canada in the second half would clearly be enough to tip the bank into hiking, and we should have enough of that evidence on hand by October.”
Still, some economists have pushed back the possibility of a rate hike until early next year due to continuing uncertainty outside Canada’s borders.
“Weighing-in on the stand-pat side, the U.S. economic soft patch is dragging on, as we count down to potential ‘credit events’ on both sides of the Atlantic,”said BMO Capital Markets economist Michael Gregory.
“Pulling on the tighten-soon side, Canadian domestic demand performance in Q2 might not be as bad as initially posited, owing to a surprising surge in home construction, while the output gap could be smaller . . . and closing quicker . . . if the latest Business Outlook Survey is any guide.”
The Bank of Canada is expected to provide more details on its economic outlook on Wednesday when its releases its Monetary Policy Report.
Rates increasing from 111-year, all-time lows now or soon!
Below is a great blurb on what is happening with yo-yo predictions of the future of mortgage rates. Get pre-approved now, consider locking-in if you were going to OR redo your mortgage now for the last of these low rates!
OPINION:
The laws of gravity dictate that what goes up must come down but I’m afraid, when it comes to the laws of economics and interest rates, what goes down must come up. Ultra-low interest rates are only a short-term solution and not sustainable in the long run. This is something which all economists agree on. Unfortunately this is the point where the common consensus ends and opinions diverge. The issue which is most divisive amongst the experts at the moment is exactly when these rate hikes will begin. As recently as a month ago many experts were predicting that rates would remain at their current levels until as late as March of 2012. A tumultuous week in the markets has seen many of these experts revise their predictions, with many now citing September as the month to bring a halt to the rate freeze.
Surprising inflationary reports for May demonstrated the fastest annual rate in eight years. While Mark Carney previously highlighted the transient threat of rising gas prices, which witnessed a 30% rise, gas prices were not alone in driving the inflation. Even the core rate, which strips out the more volatile prices of food and fuel, rose to a rate of 1.8%, quickly racing towards the Bank of Canada’s 2% target rate. With Canadian inflation now standing at 3.7%, exceeding those of Australia (3.3%); Mexico (3.3%); Chile (3.3%) and Columbia (3.0%) the calls for increased rates have grown ever louder. The fact that these countries all have short-term rates exceeding 4%, while Canada’s lingers at 1% only strengthens the case for a rate increase.
This week also saw a dramatic surge in 5 year bond yields. On Monday the yield had fallen to 2%, leading many to speculate that lenders would be forced to further drop fixed rates, which have already been subject to a series of slashes in the last few months. However these calls were short-lived as yields rebounded strongly in the face of the inflation report combined with renewed hopes that the European Central Bank could be able to prevent the default of Greek debt.
So what does this mean for your mortgage?
It means that if you are looking for pre-approval for a purchase or refinance there has never been a better time to secure your rate with Mortgage Mark while rates are still low. For those of you in a variable rate we’d like to reassure you that we still think this is still a good option. However our variable rate clients should prepare their finances and make sure they will be able to handle a potential increase to their payments coming in September. If you would like further details on any of the information listed here we implore you to call Mark Direct at 403-681-4376 for our sound, unbiased mortgage advice.
Don’t be afraid to leave your bank for a better rate
Don’t be afraid to leave your bank for a better rate
Jay LaPrete
A new survey from CMHC says the vast majority of Canadians renew their mortgages with their original lender, but you can save thousands over the life of a mortgage by looking at competing rates from competing institutions and mortgage brokers.
Garry Marr, Financial Post · Jun. 23, 2011 | Last Updated: Jun. 27, 2011 7:47 AM ET
Are the banks doing an incredible job of retaining customers or are Canadians just too lazy to shop around when renewing their mortgages?
One finding of a survey by Canada Mortgage and Housing Corp. released this week was that 89% of consumers renewing their mortgage stay with the same financial institution. And 68% stay when they are doing a refinancing.
“They stay with the lender because of rate and they leave the lender because of service,” says Pierre Serré, vice-president, insurance product and business development, with CMHC.
Consumers are more aggressive shoppers when they are seeking a mortgage to buy their first home than they are upon renewal. Only 57% of first-time buyers took out their mortgage with their existing financial institution.
Rob McLister, a mortgage broker and editor of Canadian Mortgage Trends, says the banks are doing more to retain customers but there is a pretty good chance you won’t get the best deal if you renew automatically.
“Most of the time people do some rudimentary research before they go back to their lender. Not so long ago people would just take the renewal letter, sign it and send it back. It still happens but not as much anymore,” he says.
Mr. McLister says the banks “are not as stupid” now and when they send out renewal rates they have special offers. The posted rate on a five-year fixed closed mortgage today is 5.39% but he’ll see clients get offers in the mail as low as 4.04% in a renewal letter. The problem is a broker could probably get you 3.59% — meaning you just left 45 basis points on the table.
On a $250,000 mortgage at 4.04% paid monthly and amortized over 25 years, the monthly payment would be $1,320.48, with the interest cost during a five-year term at $47,014.79. Chop the rate down to 3.59% and the monthly payment drops to $1,260.09 ,with the interest over the five years falling to $41,658.85.
If you were crazy enough, or lazy enough, to take the posted rate, you would pay $1,510.01 monthly for the same mortgage and your interest cost would jump to $63,201.92.
Let’s just say it pays to shop around. So why don’t more people do it?
There is a perception that it’s difficult to switch banks, plus it will cost you some money to switch. Yes, it’s a hassle but for $5,000-plus, count me in. As for the costs, the bank you are switching to will often cover your legal costs. Even if it doesn’t or say you face a discharge fee of $300, that’s small price to pay upfront.
Mr. McLister says if you change the terms of your mortgage and refinance, it could cost you as much $700 to switch, something you would have to do if you have a home-equity line of credit or have a collateral charge on your mortgage.
Elton Ash, regional executive vice-president with Re/Max of Western Canada and a long-time realtor, says for most people if the customer service is good, they stay.
“Unless the lender has really screwed up, they stay,” says Mr. Ash says. “It’s like realtors, not all of them charge the same fee. There are lots of discounters out there but it’s based on service levels more than costs and fees, if it’s relatively competitive.”
The banks are more competitive these days for existing customers. Part of the reason is it can cost a financial institution up to 30 basis points to attract a new customer, so why not just spend the money on retaining existing customers?
“We start calling customers in advance to remind them their mortgage is coming up,” says John Turner, director of mortgages at Bank of Montreal. “It is an increasingly competitive marketplace and customers are shopping. It’s in our interest to advise the customer of their options. That could include refinancing the mortgage overall.”
Farhaneh Haque, regional manager of mobile mortgage specialists with Toronto-Dominion Bank, says her bank starts calling customers as much as 120 days before renewal to discuss options.
“This all about relationships, they are not going to up and leave for a five-basis-point difference,” Ms. Haque says.
She’s right. A 0.05 percentage point is not a great reason to sever your relationship. But renewal time is a great time to test your relationship with your bank and get it to show you some love — or a better rate.
Financial Post
gmarr@nationalpost.com
Variable rates are still really good.
It’s that time again. When Mark Carney and his cohorts ascend Mount Olympus once more for the latest round of talks to decide the immediate future for Canadian mortgage holders.
The prevailing feeling however is that little will result from this month’s scheming and plotting. Another meeting will pass with rates unchanged and the variable rate mortgage holders can rest easily until July 19th signals the next round of talks. While some speculators – who haven’t been paying enough attention to our blog – earlier in the year cited this meeting as the one to kick off a series of interest rate rises, it now appears those speculators were somewhat premature in their estimations. Recent developments have meant it is now highly unlikely we will see a rate increase tomorrow, Tuesday, May 31, 2011.
Economic growth for the first quarter in the US, Canada’s primary trading partner, came in at a highly disappointing 1.8% with consumer spending slowing. And while Canada’s strong dollar has seen investment increase and manufacturing experience a long overdue rebound, these are still highly uncertain times for the Canadian economy. As expressed by Governor Mark Carney earlier this month, fears persist that rising commodity prices, combined with an inflated currency could impede Canada’s ability to increase demand in the US. The commodity boom is no longer serving Canada in the way it had previously during China’s rapid expansion. These concerns combined with the ever worsening European debt crisis and the impending impact of fiscal austerity in the US driven by irrational desires to cut the budget mean a rate hike tomorrow is highly unlikely.
While we feel that interest rate rises are coming before the end of the year we still feel the variable rate offers the greatest value for money. However we always advise our clients that if they feel ill-suited to the uncertainty of a variable rate, they should opt for a fixed. And the good news is that being adverse to risk has rarely been so well rewarded, with fixed rates plummeting in recent weeks. Fixed rates, as we predicted they would, have fallen repeatedly and there has never been a better time to opt for fixed. If you have any questions about anything you’ve read here or would like to hear how the impending rise in prime may affect you, please feel free to contact us at403-681-4376 for sound, unbiased mortgage advice.
Upcoming Interest Rate Announcement – No Change Anticipated
It is almost that time again, when eyes will turn towards Mark Carney and the Bank of Canada to see if interest rates will stay put again this time around.
The next announcement, slated for Tuesday May 31, comes at an interesting time. Throughout the first part of this year, it was widely believed that interest rates had stayed as low as they could, and for as long as they could, and the prediction was that rates would begin to creep up as early as this spring.
However, as with many predications, several things were not foreseen in the forecasting.
What has happened most notably in advance of this latest announcement- was unpredicted behaviour on a number of fronts. Consumer prices across many categories have been rising rapidly (although fell slightly below expectations last month), but are clearly displaying an upward trend. Inflation, while still manageable, is running a little too high to be ignored as a factor as well.
So, rates will rise at some point, but given the existence of some volatile conditions in the market, and fears that a rate hike will erode an already tenuous hold on affordability due to rising prices, the question is, is that time now?
According to a survey done by Reuters last week, forecasters predict that a rate hike will not happen until Q3 2011. It is widely believed that rates will go up to 1.25% in the third quarter from the current 1%. Almost unanimously, the forecasters polled agreed that the announcement on May 31 will be a rate hold- again.
Supporting these findings, three of the major banks have also indicated that they don’t expect to see rate hikes until the fall either.
If all of this comes to pass, it is good news for the Canadian housing market. The time-limited offer of ultra-low interest rates will get extended. Coupled with the fact that this will end at some time contributes to a sense of urgency as well.
How does this translate into daily business for Real Estate and for the Mortgage professions? Propertywire.ca asked some members of the community.
Tara Gibson, Mortgage Broker, TAG Financial – Mortgage Alliance TAG Mortgages, agrees that rates will remain steady for the time being, but thinks that an increase could come as early as the summer. “In my opinion, our strong dollar is enough to predict that we won’t see an increase in interest rates this time; more likely in July. The question is, will discounts on Prime change with the lenders? I think we may start seeing this compress a bit soon enough; in fact, some lenders have already started to close the gap. Many clients are currently choosing to go with a variable rate; simple case of supply and demand, prices go up with increased demand.”
“Despite all the pressure to see interest rates increase, industry experts believe that the Bank of Canada and lenders will increase rates at a slow rate. Advice to borrowers, if you want a variable, get in on the rate holds before we see more lenders change the discount! Further to that and much more important, global uncertainty is only postponing the inevitable, rates WILL go up so make sure you are fully prepared to handle the change when you go to renew your mortgage in 5 or 10 years!”
Trish Pigott,Broker/Owner, Primex Mortgages agrees too that status quo will be the order of the day on Tuesday. “I’m sure they are going to remain steady and unchanged. The majority of economists were predicting July as our next increase but they are now changing that until September and even some as early as next year. With our global economy in the state it’s in, I can’t see it changing much until the rest of the world stabilizes.”
Calgary region MLS sales and prices forecast to rise: CMHC
Good news:
House sales up 5%
Prices up 1%
CALGARY — A report by Canada Mortgage and Housing Corp. forecasts MLS sales in the Calgary region to increase by nearly five per cent this year compared with a year ago while the average sale price will rise by just over one per cent.
The CMHC’s Spring 2011 Calgary Housing Market Outlook, released Monday, predicted MLS sales in the Calgary census metropolitan area would hit 22,000 this year, up by 4.8 per cent, and increase a further 2.3 per cent in 2012 to 22,500 transactions.
The agency forecast the average sale price to increase by 1.1 per cent this year to $403,000 while it would jump another 2.2 per cent in 2012 to $412,000.
Low interest rates seen sticking around – fuel for the Variable rate side
Low interest rates seen sticking around- great news for the variable rate people. Remember with a broker lender you lock-in at the best broker rate for the day when you lock in. With the banks you lock in at Posted (or Posed-1% if they pretend that they love you – and they actually love your money, not you.)
That means that for today the broker rate is 3.99% for a 5 year. Posted is 5.66%. If “the bank loves you” you get 5.66-1% = 4.66% BUT you should have had 3.99% at a broker bank.
So would you love your bank back when that happens?
MARTIN MITTELSTAEDT
Tuesday’s Globe and Mail
Interest rates have recently being going somewhere unexpected: down.
At their trough last week, the yields on 10-year U.S. Treasuries, the benchmark North American rate, touched 3.11 per cent, the lowest level in six months and more than half a percentage point below their February peak.
Yields on 10-year Government of Canada bonds have fallen, too, and are now virtually identical to their U.S. counterparts.
The sliding rates have surprised many market watchers. With the United States government bumping up against its debt ceiling, inflation ticking upward, and a growing debt crisis in Europe, most expected interest rates to be increasing.
While predicting the future for rates is notoriously difficult, some observers believe that the current low-rate environment may continue for a while. If so, it will mean pain for savers, but good news for borrowers.
A drop in interest rates is equivalent to a sale on the price of money, and corporations are already rushing to take advantage of the easy lending conditions, even if they’re in no immediate need of funds. A case in point is Google Inc., which has $37-billion (U.S.) in cash and marketable securities on its balance sheet, but raised $3-billion from a bond issue last week anyway. Mortgage rates have fallen, too – good news for homeowners looking to refinance.
But lower rates have not turned out so well for some of the market’s savviest players, including Bill Gross, the founder of Pimco, the world’s biggest bond fund. Earlier this year, he sold his U.S. Treasuries, because he thought interest rates were poised to rocket higher, which would drive down prices of bonds.
It’s difficult to fault his logic: only a few months ago, the case for higher interest rates seemed so compelling.
Governments around the world are carrying bloated deficits and massive borrowing needs. In the United States, politicians have yet to agree on any clear path to deficit reduction, despite more than $1-trillion in annual red ink. Meanwhile, oil has been trading consistently around the $100-a-barrel level, thereby lifting inflation, another bond-market negative.
And the U.S. Federal Reserve is no longer putting its thumb on the scale. In less than six weeks, it is going to end its program of quantitative easing, under which it is buying $600-billion in Treasuries to goose the economy. Many bond-market followers believe the Fed’s massive buying binge has been propping up Treasury prices and keeping yields artificially low.
So what has been pushing rates lower in recent months?
A weaker-than-expected recovery is the major culprit. “The global economy, and the U.S. economy in particular, is not on quite as solid a recovery track as people were imagining in the very optimistic days of six months or so ago,” observes Peter Buchanan, senior economist at CIBC World Markets.
A slew of recent statistics underlines that weakness, ranging from the poor state of U.S. home sales to the slowing pace of U.S. manufacturing growth. Meanwhile, the Japanese economy, the world’s third-largest, is shrinking and creating a further drag on global commerce, although few foresee a double-dip recession.
“We’re looking ahead toward a bit of a cooling in economic growth,” said Paul Dales, senior U.S. economist at Capital Economics, who foresees output in the U.S. rising about 2 per cent this year.
That level of growth won’t be “anything to celebrate but it’s nothing like the recession we saw previously,” he said.
Another factor driving rates lower has been the early May rout in commodities, which dampened some of the worry on the inflation front. In addition, the recent sluggish performance of the stock market suggests that investors are getting nervous and growing more willing to buy super-safe government bonds.
Mr. Dales believes the current trends have room to run, and that rates will surprise to the downside.
He predicts U.S. 10-year Treasury yields could slip to 2.5 per cent in the low-growth, less inflation-spooked environment he foresees ahead.
If growth continues to be slow, lower rates might be staying around for a while.
Mr. Buchanan says the most likely scenario, given the poorer economic outlook, is for the Fed to hold off on raising rates until 2013. He believes the yield on Treasuries will rise gradually, instead of falling further, getting back to 3.4 per cent by the end of this year and to 4 per cent by the end of 2012. http://www.theglobeandmail.com/report-on-business/economy/interest-rates/low-interest-rates-seen-sticking-around/article2032075/
Why I paid $10,000 to break my mortgage
Below is a great article about why paying the payout penalty can be worth it for you. We always do the math for you to ensure that it is a better deal AND we also include any other costs in that math – like an appraisal and legal costs – lots of other brokers do not. Ensure ALL the costs are included in the math before making the change.
Want to ensure it is worth it – give us a call for a free 5-minute mortgage checkup at 403-681-4376.
Tara Walton/Toronto Star By Bryan Borzykowski |
Last September, my wife and I started scouring the city for a new house. We were living in a cozy bungalow, but with a growing kid and another on the way, we decided it was time to move.
Buying a new house is, of course, expensive, so I wanted to do whatever it took to reduce my costs. Most of the fees couldn’t be avoided, but there was one costly payment I desperately wanted to steer clear from: The mortgage penalty charge.
I had just over 12 months left on my five-year mortgage term, which meant that I either had to break my mortgage or stay with my current lender by transferring my mortgage to my new house. The latter option would have allowed me to avoid the fee. However, my lender couldn’t give me the best interest rate.
The new lender, a bank, was offering a variable rate of 2.25 per cent, a much lower rate than my old lender was willing to offer. I calculated that over the term I’d be better off paying the fee and taking the lower rate.
It was going to cost me $10,000 to break my contract. It felt like an unnecessary cost — I paid my lender so much in interest over the four years, why would I have to cough up so much cash?
I asked my broker to see if the lender would waive the fee, even though I was using a new lender for my next house, but they didn’t. Peter Veselinovich, vice-president of banking and mortgage operations at Investors Group, isn’t surprised. “The charge isn’t negotiable,” he says.
While the penalty may seem like an arbitrary sum, it’s not a cash-grab, he says.
The lender takes mortgage funds from money invested in GICs and other products and then it pays investors interest on those investments.
The idea is to match a five-year mortgage with a five-year GIC, so investors can get paid back at the same time as the mortgage comes due.
If a mortgage is broken, the lender needs to come up with money to fill the gap between the investment coming due and the mortgage ending. Hence the fee. The lender then takes that lump sum and invests it, so it can pay investors back when its GIC comes due.
The penalty is calculated two ways: you either pay 90 days of interest or what’s called an interest-rate differential, which is a penalty based on your old rate and a new rate based on a shorter term.
For example, let’s say you wanted to exit your 5 per cent five-year term with three years left to go. The lender would look at the current three-year term rate, which, say, is 3 per cent, and then charge you interest on the difference, 2 per cent, for 36 months. The sum also depends on how much money you still owe the bank.
However it’s calculated, the payment can be huge.
Darick Battaglia, a mortgage broker and owner of Dominion Lending Centres’ Barrie location, says that while it may seem as though people have to empty their bank account to pay the penalty, ultimately, by paying the lower rate, they’re getting that money back in mortgage savings.
Whether you’re moving houses, or just want to break a mortgage to take advantage of a lower interest rate, people often pay the penalty so they can free up more disposable income.
“It can help people get into a better financial position, because they have more disposable income,” says Battaglia. “They may find that it’s better to invest that money in an RRSP.”
If you’re moving, there are strategies to help reduce the penalty or even not pay it at all.
Almost all mortgages allow people to put a certain percentage of money down on a house every year; I was allowed to pay 20 per cent of my balance every 12 months.
In some cases, lenders will allow you to designate the first 20 per cent — it could be less or more depending on your lender — of the proceeds of a sale of a house towards the prepayment in order to pay down the outstanding balance and so reduce the mortgage penalty.
Battaglia has dealt with many lenders who refuse to honor this type of arrangement. They want two checks: one for the prepayment and one to pay off the mortgage.
My own lender refused to let me make one payment; I had to borrow money from my broker, who paid my prepayment three days before closing. I had to pay him back with some of the proceeds of the sale. It was a major hassle. But I did save about $1,500.
Porting a mortgage to a new house is another way to avoid the fee.
Let’s say you have $100,000 left on a mortgage with a 4 per cent rate, but you need $200,000 more for the new house. The bank will give you the additional money at the new rate, which could be 3 per cent. You’d keep the same term or extend it and now you’d pay a blended rate, in this case 3.5 per cent on $300,000.
“There are no penalty costs, because you’re still honouring the original contract,” says Veselinovich.
Most people will have to open their wallet when they break a mortgage.
While I did get my penalty reduced by making a prepayment before closing, I still had to write a cheque for about $8,000. It was painful at the time, but now that I’m in my new house, paying a new mortgage at a much lower rate, I don’t think about the penalty anymore.
Coming soon: higher interest rates
- refinance – or re-do your mortgage – and get today’s rates for another 5 years,
- roll in some higher interest payments – like LOC -Line of Credit or credit cards or,
- buy your first home before rates go up or,
- finally get that summer/ ski vacation cabin.
Call for a free 5-minute mortgage check-up while there is still time. (That may be 2 or 3 weeks from now as the bond market will smell this coming inflation pretty quickly.)
Let’s start with a little tutorial (no, please keep reading, it will be brief) and then we’ll talk about why this week’s economic data changes everything, more or less.
The Bank of Canada sets the benchmark overnight rate (the rate at which banks lend to each other). That in turn affects market interest rates on everything from mortgages through to business loans. At present, the overnight rate is at 1 percent, following three hikes of 25 basis points each last year.
The tutorial is on the ‘output gap’ which is one of the major tools that the Bank of Canada looks at to set monetary policy. Here goes.
The ‘output gap’ refers to the difference between the actual output of the economy and the potential output. Potential output basically refers to the maximum that could be produced if all inputs (like the labour force, technology, capital, factory space and all that) were used to the fullest extent that they can be without triggering inflation. That last little bit is key: when the bank says ‘potential’ they don’t mean full potential, they mean ‘potential without forcing prices higher’. It is a similar concept to what economists mean when they say ‘full employment’. In that case it does not mean everyone working, it means everyone working that can be working without wages being forced higher.
The Bank of Canada monitors the output gap as best they can, first by estimating what potential output is in any period of time, then estimating how close to potential the economy looks to be. A positive output gap means the economy is operating above potential, and that inflation is a risk. A negative gap means there is excess supply (for example, too many unemployed workers) and that inflation is not a risk, or at the extreme, that deflation is possible.
The Bank of Canada adjusts policy to try to get keep things in balance and the output gap closed – sort of a ‘not too hot, not too cold’ thing. Based on their most recent calculations, their latest estimate (which was contained in last week’s Monetary Policy Review) was that the output gap would close by the middle of 2012.
Everybody still with me? Good. Here’s the thing: as well as looking at the output gap itself, the Bank also looks at a bunch of economic indicators to see how close to capacity the Canadian economy is running. Things like industrial production, the unemployment rate, unfilled manufacturing orders – and inflation.
That last one is probably the most important, and it is the one that seems to be running most out of sync with where the Bank of Canada thought it would be. In the Monetary Policy Report, the Bank said that the overall inflation rate (which they target to be 1 to 3 percent) would peak at 3 percent in the second quarter. This week, we got the March inflation report, and we find out that the inflation rate was 3.3 percent as of March – which is decisively in the first quarter. Ouch.
So what does this mean? It means something has to change to keep the Canadian economy from overheating. That something is likely to be Canadian interest rates, and when I say ‘change’ I mean ‘go higher’.
If rates do not go higher, then the output gap is at risk of going into positive territory, which means inflation takes off even more. No way is the Bank of Canada going to let that happen.
There are other things to take into account too – the spiky Canadian dollar is an important one – but it does not take away from the big picture.
Big picture? A rate hike by July, and maybe more to come after that. And yes, watch the loonie soar in the meantime.