Earlier this month, the Bank of Canada announced that it was keeping the key interest rate unchanged at 1.00%. The following day, the Monetary Policy Report was released, outlining the factors driving their decision. Most notably, Canada’s financial conditions remain “stimulative” with household spending, business investment and private credit growth all at strong levels. Also, Canadian economic expansion is moving along as predicted and it is anticipated that the first three months of 2012 will bring strong recovery [1]. Independently, Canada could have handled an interest rate increase, but considering the less stable economies of Europe and especially our largest trading partner, the U.S., an increase would not be wise. However, Governor Mark Carney has made it clear that steps will be taken to control inflation [1].
The United States buys about 80% of our exports [2]. With their massive federal budget deficits, and recent update, the road to recovery south of the border may be a long one.
As a result, our net exports are currently weak. The increasing strength of the Canadian dollar hasn’t helped either.
Canada is sitting in an advantageous yet slightly precarious position. Our strong domestic growth boosted the Canadian real estate market, whereas the uncertainty surrounding global recovery has resulted in record low mortgage rates [2]. So, it would seem that we’re currently enjoying the best of both worlds.
What are the threats to Canada’s economy?
The U.S. economy won’t be able to handle the stress of higher interest rates any time soon [2]. Since our economy is so interconnected with the States, the low U.S. interest rates will drag along Canadian mortgage rates. Additionally, Canada’s relatively higher interest rates will attract more foreign investment, which in turn will push the Canadian dollar higher. Consequently, the raised Loonie will then cause exports to be more expensive, reducing U.S. demand and finally, slowing down our economy [2]. It’s unfortunately a vicious cycle.
Another threat to the Canadian economy is the risk of the European sovereign -debt default. Greek government debt is currently at 155% of GDP and it is expected to grow by 170% next year. (There aren’t any reports stating whether this number includes unfunded liabilities). Not only are the peripheral economies of Ireland and Portugal under stress, but Italy and Spain also have enormous debt loads with sluggish or retreating economies. As a result, the last two countries are now seeing the highest interest rates in a while. Once again, we’ve entered a vicious cycle. The higher rates make debt more expensive, consequently increasing the risk of a potential default.
If one or more Eurozone countries do ultimately default, this could have a domino effect that plunges the world into recession. In that case, we can only hypothesize what effect this would have on Canada. Perhaps our government bonds would be considered safe, drive yields down and reduce fixed mortgage rates? Or, investors may demand higher yields because sovereign debt won’t be seen as a risk-free asset [1]. Either way, we don’t really want to find out.
In the last couple weeks, the perception of the global economy has worsened further and it seems less likely interest rates will increase in 2011. Some experts are even going so far to suggest rates may fall if circumstances do not improve. One thing is certain: we are in for a long-term low interest rate environment.
How does the suffering global economy impact Canadian mortgage rates?
Naturally, a low interest rate environment is good for mortgage borrowers. Variable rates, which directly follow the prime lending rate, can be found for as low as 2.05%, and will continue to be found for some time to come.
Canada is seeing lower borrowing costs as a comparative (to other countries) safe investment, and, thus, bond yields and fixed mortgage rates are lower as well.
Both variable and fixed mortgage rates are attractive now and it is a good time to borrow in either category. Consider the spread between the two, and your tolerance for risk and variability. A good practice is to take a variable rate and use your prepayment options to benchmark your payments to a fixed rate, thereby budgeting for rate increases and paying off your mortgage faster. However, this option requires commitment and discipline.
Considering our economy and the direction of our mortgage rates are so heavily dependent on the status of others, it is difficult to make predictions. As it stands, most experts are predicting little movement in 2011 into 2012. Still, it is not out of the realm of possibility to see another global financial setback.
