SOURCE: FINANCIAL POST: Ari Altstedter, Bloomberg News | January 21, 2015
The Bank of Canada unexpectedly cut its main interest rate, saying the oil-price shock will drag down inflation and weigh on everything from exports to business and consumer spending.
The bank cut its rate on overnight loans between commercial banks by a quarter percentage point to 0.75%, a decision none of the 22 economists in a Bloomberg News survey predicted. The rate, which influences everything from car loans to mortgages, had been at 1% since September 2010. The last cut was in April 2009.
Five-year bond yields, which serve a benchmark for mortgage loans, are at a record low. Anticipation of increased lending has helped push the cost to hedge mortgage loans by banks to the highest level since August 2013, when frenzied activity in the housing market prompted authorities to clamp down.
With oil prices depressed to 5 1/2 year lows and both the International Monetary Fund and the World Bank cutting growth forecasts this month, traders have pushed out expectations for when central banks in the U.S. and Canada will raise benchmark interest rates. That’s caused the wholesale rates available to banks in the bond market to fall before the country’s traditional spring home-buying season.
“Real estate, it has nine lives,” said Benjamin Tal, deputy chief economist at Canadian Imperial Bank of Commerce, by phone from Toronto. “Every time it’s supposed to slow down because of interest rates, something bad happens elsewhere that keeps interest rates low. That’s exactly what we’re seeing now.”
The average five-year mortgage rate in Canada is a record-low 4.79%, according to central-bank data. Lower rates can be obtained from banks and other private lenders.
Rate Cut Impact
Economists say Canadian borrowers can expect mortgage rates to dip slightly in response to the Bank of Canada’s surprise move to cut its trend-setting interest rate.
CIBC chief economist Avery Shenfeld says that will likely mean a corresponding 0.25 drop in variable, or floating, mortgage rates.
Fixed-rate mortgages are also likely to see a slight decline, as they follow bond yields, which will move lower in response to the central bank’s rate cut.
The rate cut could boost sales and prices of homes in Central and Atlantic Canada, including in Toronto’s red-hot property market.
TD economist Craig Alexander says lower interest rates could spur consumers in non-oil dependent provinces such as Ontario to take on more debt, which in turn will boost the region’s real estate market.
However, Alexander says it’s unlikely that consumers in oil-rich Alberta, who are reeling from the impacts of the sharp decline in energy prices, will increase their debt loads or see sales or prices of homes heat up.
A month ago, traders were pricing in an 83% chance the Federal Reserve would raise the key U.S. rate by the end of 2015, according to Bloomberg calculations based on overnight index swaps. Tuesday, the chances were 66%. In Canada, traders now see a greater likelihood of a decrease than a raise.
The gloomy outlook has increased demand for bonds, pushing the yield on five-year debt from the Canadian government to a record-low 0.786%.
At the same time, the cost for the securities banks use to hedge mortgage liabilities, the five-year swap spread, has risen.
The premium banks must pay over five-year government securities for a five-year interest rate swap — the rate to exchange floating- for fixed-interest payments — climbed as high as 46 basis points this month.
“The banks aren’t hedging yet, but other investors are anticipating the hedging activity and they’re basically front- running the banks,” said Ruslan Bikbov, a fixed-income strategist in New York at Bank of America Corp. “Mortgage rates, basically they have to decline.”
With consumer debt including mortgages at a record level and real estate valuations still rising, Canada’s situation today echoes the summer of 2013, when the nation’s housing agency rationed guarantees on mortgage-backed securities to help keep the market from becoming a bubble. That March, then-Finance Minister Jim Flaherty, who had already tightened mortgage rules, rebuked Bank of Montreal for reducing its five-year mortgage rate below 3%.
At the time, the benchmark five-year rate was 1.3%.
“This spring, in both the investment season and in the mortgage season, we hope to again have a fresh offer that is appealing to customers,” William Downe, chief executive officer of Bank of Montreal, said at Jan. 14 conference in Toronto. “And so in that sense, it isn’t a question of competing on price. It’s a question of competing on value.”
Housing prices have continued to gain across the country, particularly in the largest cities. In Vancouver, the average home price jumped 27% since December 2008, according to the Canadian Real Estate Association. Toronto home prices rallied 49% in the same period to $521,300 in December 2014.
This year, there’s no guarantee the banks will respond to the lower rates in the bond market by lowering mortgage rates, and even if they do, there’s no guarantee cheaper mortgages will further inflate housing values, according to CIBC’s Tal.
His own research shows an estimated 30% to 40% of Canadian households are taking advantage of low interest rates to pay back their mortgages to shorten their amortization, reducing the risk of an interest-rate shock.
Last month, the Bank of Canada said housing prices are overvalued by as much as 30%, posing an “elevated” risk to the domestic financial system.
“If we borrow more, that will add to the ultimate adjustment,” Tal said. “But that depends on what we do. We have seen in the past that Canadians use low interest rates to actually pay down debt faster, as opposed to add to their debt. If that’s what we do, it’s a good thing.”
Bloomberg News, with files from the Canadian Press