BoC holds rates; bets stimulus, global gains will ease economic pain.

The Bank of Canada is leaving its key interest rate unchanged, betting that a burst of federal infrastructure spending and a global recovery will lift the Canadian economy out of its funk.

Governor Stephen Poloz and his central bank colleagues opted Wednesday not to cut the bank’s overnight rate, now set at 0.5 per cent, in what analysts had predicted would be a very close call.

Looking beyond the ongoing stock market correction and a continued slide in the price of oil, the bank insisted 2016 will be a turnaround year for the economy.

“While risks to the world outlook remain and have been reflected in sharp price movements in a range of asset classes, global growth is expected to trend upwards in 2016,” the bank said in a surprisingly upbeat statement.

The bank insisted Canada’s wrenching pivot from a resource-driven economy to one powered by other activities is “under way” and that the job market remains “resilient” outside the resource sector.

But the bank acknowledged that the economic environment remains “highly uncertain.” And it once again slashed its growth forecast for 2016 – to 1.4 per cent from 2 per cent – and warned that more turmoil is in store for the oil patch.

By not cutting rates, Mr. Poloz may also want to avoid triggering an even sharper dive in the Canadian dollar – one of the world’s weakest currencies in recent months. Lower Canadian interest rates typically depress the currency as investors seek better returns elsewhere, including the U.S., where the Federal Reserve has begun to hike its own rates.

Most analysts say a rate cut later this year remains a possibility. CIBC World Markets economist Nick Exarhos said Mr. Poloz appears “willing to wait and see what the Finance Minister [Bill Morneau] provides as a bolster to the economy before pulling the trigger on any more monetary easing.

The decision to not cut now suggests the central bank was worried about knocking the dollar down further and causing already debt-laded Canadians to borrow more, Bank of Montreal chief economist Douglas Porter said.

The cheaper dollar has also caused angst among many Canadians who now face sharply higher prices for groceries and other imported goods, as well as winter getaways to the U.S. Even exporters, who stand to benefit most from a low dollar, had warned that a further drop would not be helpful.

The dollar fell below the psychological threshold of 70 cents (U.S.) this week, dragged lower by the dropping price of oil and anticipation of a possible Bank of Canada rate cut.

Speaking to reporters in Ottawa, Mr. Poloz acknowledged that the bank’s decision not cut rates again was influenced by fears that a more pronounced drop in the dollar could spur unwanted inflation plus the expected fiscal stimulus coming from the federal government.

“The likelihood of further fiscal stimulus was an important consideration,” he said.

At the same time, “another rapid depreciation” in the Canadian dollar could send inflation sharply higher as imported goods become pricier, he said.

“We need to be patient,” Mr. Poloz added.

The bank pointed out that its latest forecast does not factor in the “positive impact of fiscal measures expected in the next federal budget.” The new Liberal government has promised to run deficits and boost infrastructure spending by roughly $5-billion a year, but is under pressure to do even more. The bank said the size and timing of this stimulus won’t be known until the federal budget, expected in March.

Mr. Poloz acknowledged that Canada’s economy suffered a “setback” in the final three months of last year, but he dismissed this as a largely temporary stall.

Some economists say the economy may even have shrunk in the fourth quarter – in what would be a third quarter of negative GDP in 2015.

Instead, the bank estimates that gross domestic product grew a slim 0.3 per cent in the fourth quarter and is poised to gather momentum as the year progresses. The bank blamed the stall on weaker-than-expected U.S. factory production, lower business investment at home and various temporary factors, including a strike by Quebec public sector workers.

Growth is expected to rebound in 2017 to 2.4 per cent, or roughly in line with the bank’s previous forecast in October.

The bank has also pushed back, once again, its estimate of when the Canadian economy will return to full capacity – to “around the end of 2017” from mid-2017. This suggests the Bank of Canada could keep interest rates at today’s low level for up to another two years, even as the Federal Reserve ratchets up U.S. rates.

The bank expects that the depressed price of oil will recover – at least in the medium term. The price of crude has plummeted to near $30 a barrel from more than $100 in the past two years.

“The risks to oil prices are tilted to the upside,” the bank said in its monetary policy report. “The significant reductions in oil investment since late 2014 could leave future demand increases unmet, putting upward pressure on prices and drawing investment back into the sector.”

The bank’s forecast, however, assumes that oil prices will stay “near their recent levels.”

The bank is also warning that conditions could still get much worse in the oil patch, where job losses and production cuts have already plunged the province of Alberta into recession. “Low oil prices . . . will require more fundamental changes to operations and could be more profound than the already difficult adjustments made in 2015,” the bank said in its monetary policy report.

The bank pointed out, for example, that even at prices of $40-$50 a barrel (for West Texas Intermediate crude) many industry executives say the “current composition of the industry is unsustainable.”

Many oil sands operations are “approaching break-even prices on a cash flow basis,” which could trigger further cuts to production and investment it said.

The bank says investments by energy companies will fall 25 per cent this year, or even more sharply than the 20 per cent drop it projected just three months ago. Investment plunged 40 per cent last year.

Click here for the full article and video.

How Will "The Liberal Effect" Impact Mortgage Rates?

Last week's Federal election saw the decade long rule of the Conservatives end and the Liberals retake power. So, how will "The Liberal Effect" impact mortgage rates?

Our friends at Canadian Mortgage Trends outline six things we can expect from Mr. Trudeau over the next few years.

The Liberals’ new majority gives them all the power they need to influence Canada’s mortgage market. Interest rates, mortgage policy and affordable housing initiatives will all be affected.

Here’s some of what the mortgage market can expect from Mr. Trudeau’s new government:

1. Higher bond yields: Balancing the budget is not a priority for the Liberals until 2019. Trudeau is expected to go on a spending spree and bond traders aren’t keen about it. It suggests a greater supply of government debt and potentially higher long-term yields to come. That, of course, could mean at least slightly higher fixed mortgage rates than we’d otherwise see.
2. A More Hawkish Poloz: The odds just dropped for a cut in prime rate. More spending by Ottawa puts less pressure on governor Stephen Poloz to stimulate the economy with rate cuts. The implied probability of a rate hike by next October has almost doubled, from 8% yesterday to 15% as we speak.
3. Wider RRSP Access: The Liberals say they’ll open access to the RRSP Home Buyer’s Plan, particularly for homebuyers coping with significant life changes (divorce, death of a spouse, a sick or elderly family member, etc.). More access to down payment funds will prop up housing sales and home ownership slightly, and support home prices.
4. More “Affordability”: The Liberal platform includes a review of housing policy in high-priced markets. The new government will “consider all policy tools that could keep home ownership within reach.” What that means, we’ll have to wait and see. It could definitely be positive for renters and income property investors, given the Liberals have promised to “direct CMHC…to provide financing to support the construction” of new rental housing.
5. First-timer Support: Trudeau’s government will add more flexible programs for first-time homebuyers. This could mean any number of things, potentially even higher amortization limits for new buyers.
6. New Blood at the DoF: The Liberals will be installing a new Minister of Finance, who has enormous power over housing regulation. Will he or she be as hands-off on mortgage policy as the outgoing Joe Oliver? We’re guessing not. We’ll likely have an answer by the time the Liberals release their first budget next spring.

Here’s more on the Liberal housing platform.

Fed Postpones Rate Hike

The Fed kept the overnight rate unchanged today, choosing to delay an increase owing to stubbornly low inflation, an uncertain outlook for global growth and recent financial market volatility. It appears that recent losses in China's equity markets reflect deeper worries over growth prospects for the world's second largest economy. Slowing growth in China has helped to trigger a dramatic drop in commodity prices, especially oil, which has put further downward pressure on U.S. inflation.

Currently, inflation in the U.S. over the past twelve months is only 0.3 percent, well below the Fed's target of 2 percent. Much of this is owing to the strengthening in the U.S. dollar and falling commodity prices. Also, despite tightening labor markets, wages gains have remained extremely muted.

By holding the benchmark federal funds rate at zero to 0.25 percent, policy makers revealed their continuing uncertainty that inflation has not moved back to their 2 percent target, despite gains in the labor market. The Committee expects inflation to remain low for many months.

Federal Open Market Committee (FOMC) members revised down their expectation of unemployment this year and next to a few basis points below the current level of 5.1 percent. Inflation expectations were revised down, as were projections of the federal funds rate even though growth is expected to perform well.

Most participants expect the Fed to raise interest rates this year, although four Committee members expect the first increase to be delayed to 2016. Richmond Fed president Jeffrey Lacker dissented with the Committee's decision, saying he preferred to raise the target rate by 0.25 percentage points now.

Concern was expressed regarding global economic uncertainty. Clearly, the slowdown in China has caught the Fed's attention. Headwinds from abroad are affecting the Fed's forecast. The federal funds rate is not expected to return to "normal" levels until the end of 2018. So when interest rates do rise, they will do so only gradually.

The median of the Fed's long-term forecast was lowered to 3.5 percent from 3.8 percent in June. The Fed is forecasting a federal funds rate of 0.4 percent for 2015, 1.4 percent in 2016, 2.6 percent in 2017 and 3.4 percent in 2018, which all are lower than the central bank saw in June. The central bank projected less inflation, trimming its forecast for inflation this year, 2016 and 2017, and not seeing inflation reach the 2 percent target until 2018. At the same time, the Fed got more optimistic on the unemployment rate, lowering its projections for 2015, 2016, 2017 and the longer term.

This is good news for Canada where the economy is  much weaker than in the U.S. and where the Bank of Canada is at least a year away from tightening. Chairman Yellen mentioned Canada specifically in her press conference, suggesting that the slowdown in Canada arising from the oil price rout is important as Canada is "an important trading partner" with the U.S. Clearly, interest rates will remain low for a long time and when they do rise, they will do so only gradually.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Bank of Canada Maintains Rate

As expected, the Bank of Canada refrained from cutting interest rates at today's policy meeting. The recent economic news has shown a marked improvement, precluding the Bank from following on the previous two rate cuts this year. The key policy overnight rate is only 50 basis points (one-half of one percentage points) and another 25 basis point (bp) cut would only reduce the Bank's ability to take action, if needed, in the future.

The slowdown in the Canadian economy in the first half of this year had nothing to do with interest rates and had everything to do with the massive decline in oil prices. As the Bank has noted, "financial conditions are accommodative and provide considerable support to economic activity".

In addition, a 25 bp rate cut would only translate into a 12-to-15 bp cut in mortgage and other consumer and business borrowing rates, as we have seen with the January and July cuts. The reason is the cost of funds for the lenders has risen relative to risk-free government five-year bond yields--normally linked to mortgage rates--as investors risk appetites have declined. This rise in so-called credit spreads reduces the stimulative effect  of any rate cut by the Bank of Canada.

Moreover, the interest-sensitive sectors of the Canadian economy--housing, autos and other durable goods purchases--are already booming. Business investment has declined sharply, but only in the oil patch, which would not be reversed by lower interest rates. Another rate cut would only encourage increased household indebtedness and, at the margin, make little difference.

The good news is that the U.S. economy has rebounded sharply from the first quarter slowdown, with second quarter growth of 3.7 percent surprising on the high side. This has helped to boost Canadian exports, particularly for autos and aircraft. As the Bank expected, the weaker Canadian dollar has spurred the demand for Canadian products in the U.S. and elsewhere.

To be sure, the Chinese economy has slowed, putting downward pressure on certain commodity prices important to Canada's exports, but the pick up in the U.S. has finally provided a meaningful offset.

The Bank of Canada is at last seeing the stimulative effects of its earlier rate cuts and is confident that the five-month decline  in economic activity has halted with the stronger-than-expected 0.5 percent growth in June. The increase in June was broad-based. Also, more recent data show a strong uptick in employment growth. Third quarter GDP growth is in train to meet or exceed the Bank's forecast of 2.5 percent, a welcome reversal of the first-half slide.

While core inflation has been about 2 percent, the Bank judges that the underlying trend in inflation remains at about 1.5 to 1.7 percent.

To be sure, the heightened volatility in financial markets, the slowdown in emerging economies and the potential further decline in oil prices will keep the Bank ever watchful. If the rebound in economic activity peters out later this year, which I doubt, the Bank will act quickly to cut rates once again. The next policy announcement date is October 21, just two days after the Federal election

 

Dominion Lending Centre’s Chief Economist: Canada’s Mortgage Industry Is Solid

Sherry Cooper, Chief Economist, Dominion Lending Centres, says there are no signs of widespread fraud in Canada’s mortgage industry. She joins BNN to discuss the role of regulators and financial institutions in preventing fraud.
Click here to watch the video

Bank of Canada Cuts Rates 25 bps...Canadian Dollar Plunges

Dr. Sherry Cooper Chief Economist, Dominion Lending Centres has some insights on the Bank of Canada Rate Cut:

The Bank of Canada cut its overnight rate target by 25 basis points to an historically low 0.5 percent today. The loonie immediately plunged to 77.5 cents U.S., down a full cent. The disparity between monetary policy in Canada and the U.S. is especially evident today as Janet Yellen, Chair of the Fed, is testifying before Congress this morning stating that she expects to raise interest rates in the U.S. this year.

The Bank of Canada judges that the underlying trend in inflation is about 1.5 to 1.7 percent, below its 2 percent target. Moreover, they substantially reduced their estimate of economic activity this year and argue that the lower outlook increases the risk of further declines in inflation. Earlier this year, the Bank argued that economic growth would revive from the Q1 contraction in the second quarter. This clearly did not happen. Following a 0.5 percent decline in real GDP growth in the first quarter, the Bank is now estimating a further 0.6 contraction in Q2, bringing their forecast for 2015 growth to a mere 1.1 percent , down from their earlier forecast of 1.9 percent.

The disappointment has been in the energy sector and weaker-than-expected exports of non-commodity and no-energy products in the second quarter despite the decline in the Canadian dollar. The Bank points to a slowing in the global economy to explain the weak trade numbers. The U.S. economy experienced considerable weakness earlier this year owing to transitory factors.

Moreover, despite today's release of 7 percent growth for China in Q2, the Bank attributes lower commodity prices to the weakness in China. I agree and suggest that the Chinese GDP figures are suspect and are likely closer to 6.8 percent (or lower) as most economists expected. Clearly the economy there has been slowing and recent government intervention in the Chinese stock market shows it will stop at nothing to appear to be in control.

The question in my mind is the effectiveness of a rate cut at this time. The follow-through at the financial institutions will likely be partial, as it was with the last rate cut in January. The prime rate and mortgage rates are likely to fall by no more than 10 to 15 basis points from already very low levels. At the margin, this might boost housing and consumer credit a bit, but these are not the sectors most in need of stimulus. Moreover, the Bank reiterated that household imbalances (debt levels) remain elevated and could edge higher. This is obviously a great time for borrowers to lock-in rates.

It is unfortunate that fiscal stimulus is off the table. Much-needed infrastructure spending should be increased as a proactive counter-cyclical measure that would be far more effective than a rate cut from historically low levels. But, alas, that is not going to happen.

The Bank now forecasts that growth will accelerate to a still modest 1.5 percent in the current quarter and 2.5 percent in Q4. Growth in 2016 is now forecast at 2.3 percent, down from the 2.5 percent forecast in April. Even with this rebound, the economy will not return to full capacity until the second half of 2017.

I think we will be lucky to achieve these moderate growth levels. The biggest risk to the global economy is a continued slowdown in China, the number-one commodity consumer, which would put additional downward pressure on commodity prices. As well, the recent nuclear agreement with Iran will, in time, increase oil supply further depressing energy prices.

The Bank of Canada is running out of room. There are now only 50 basis point between here and the zero interest rate boundary. What's more, the Bank admits that "financial conditions for households and businesses remain very stimulative." After the October election, fiscal stimulus will be essential

How To Pick The Best Mortgage

Here are some things to consider when picking your mortgage:

 

Amortization period

The size of a mortgage loan payment is calculated based on a length of time you agree to paying off that debt—this is called the amortization period. In Canada, the standard amortization period is 25 years, but home owners can also opt for amortization periods as short as one year and longer than 25 years (although the lender will really scrutinize your application if you go above 25 years, and may tack on an extra fee, or require more than 20% down payment on the property purchased).
Because of recent legislation, all Canadian home buyers must now qualify for a mortgage based on a 25-year amortization and the posted 5-year fixed rate—and this applies even if you opt for a longer or shorter amortization, or select a variable rather than fixed mortgage.
But it’s not just about qualifying for the mortgage. The amortization period is integral in the best mortgage decision because it will decide how much or how little interest you will pay during the life of the mortgage loan. Remember that the longer the amortization period, the more interest you will pay. So, a shorter amortization period will lower your overall cost of borrowing. Also, each payment—whether you make monthly, bi-monthly or weekly mortgage payments—consists of both interest and principal. That means any prepayment you make to your mortgage will help reduce your principal, and this eventually reduces the overall interest you pay on this loan.

Term

Because interest rates can change quite dramatically over time, most lenders don’t want to negotiate a 25-year loan. For that reason, your mortgage amortization is broken up into terms. The term is shorter than the amortization period and locks you into the negotiated rates during that specified period of time. For instance, on a 25-year amortization, you might agree that for the next five years you will pay 3% interest on a fixed mortgage to your lender. The length of term you choose will depend partly on whether or not you think interest rates will rise or fall. Be aware that your current lender is not obligated to renew your mortgage for another term. While most lenders will, you may still want to shop around for a new mortgage term to ensure you’re getting the best deal.

Open mortgage

An open mortgage means you can repay the loan, in part or in full, at any time without penalty. Interest rates are usually higher on this type of loan—for instance a home buyer in Ontario will pay 4.99% for a 1-year open mortgage vs. 1.99% for a one-year closed mortgage, as of July 3, 2015. Still, if you plan to sell your home in the near future or expect a large sum of money, an open mortgage can be a great option—especially since most lenders will allow you to convert from an open to a closed mortgage at anytime (and switch you to lower rates). But always shop around for a mortgage and never settle for the rates your current lender offers.

Closed mortgage

A closed mortgage usually offers the lowest interest rates available and it’s an excellent choice if you want security in knowing exactly how much your housing will cost you at any given time. However closed mortgages are not flexible and there are often penalties and restrictions when it comes to prepayments. Over the last decade many lenders will now allow you to prepay or make lump sum payments on a closed-term mortgage, but if you exceed these allowances there can be big penalties.

Fixed mortgage

Fixed rates are based on movement in the bond market (the benchmark for a 30-year fixed rate mortgage is the yield of a 10-year bond). As bond prices rise, fixed rates will also rise and the spread between the two reflects the risk investors are willing to take when they move their money from a secure product, like bonds, to invest in a less secure investment, such as mortgage securities. There are times when that spread becomes very wide or very thin, such as the subprime mortgage crisis of 2008/2009. When this happens, rates can seem out of wack making it much harder to determine the advantage of disadvantage of fixed vs. variable options.

Variable mortgage

Variable rates are priced according to changes in money market conditions. That means if the prime rate goes up — based on changes made to the Bank of Canada’s overnight rate — then variable rates will go up. (For more on how the BoC interest rate changes impact mortgages see this post.) While these changes are more volatile, they don’t typically occur more than once per month. That means the interest rate on your mortgage could change from month to month, however your monthly payments will stay the same (but the amount applied towards the principal will change as the rate changes).