GLOBAL UNCERTAINTY KEEPING RATES LOW
Global events have once again turned attention towards the interminable Euro-saga, which this time is seemingly closer to a conclusion. Unfortunately, whether that conclusion is orderly or catastrophically disorderly is still up in the air. What we do know is that the resulting uncertainty and risk-aversion has set bond yields on a steep descent back towards historic lows. For at least one day, Government of Canada five-year yields fell to just 1.06 per cent, a mere 6 basis points off of the prevailing Bank of Canada overnight rate.
Mortgage rates had been inching upward in the second quarter as an improved economic outlook and a more hawkish tone from the Bank of Canada pushed key bond yields sharply higher. However, global financial markets have since been hit with a tsunami of anxiety regarding the Eurozone and the subsequent flight to safety has again sent Canadian bond yields tumbling to historic lows. Rapidly falling bond yields will likely open the door for banks to reduce posted mortgage rates, though tighter proposed lending standards, a rationing of portfolio insurance, and more intense regulatory scrutiny may place a floor under rates. We are forecasting that the benchmark five-year fixed mortgage rate will average 5.3 per cent for the remainder of the year.
Shorter-term and variable rates, which are more immediately impacted by changes to the Bank of Canada policy, will likely remain fairly constant until the late fall or early winter when the Bank may begin to withdraw monetary stimulus with a 25 basis point rate hike. However, a rate hike viewed as almost certain a few weeks ago now seems much more unlikely in the current global financial climate.
Growth and Inflation Outlook
The direct economic linkages between Canada and Europe are not of a large enough magnitude to drag down Canadian economic growth on their own. The ultimate impact of the Euro-crisis on the Canadian economy, therefore, depends crucially on the impact of the Euro-crisis on global financial markets. Thus far, actions taken in the winter of 2011 by the European Central Bank to calm inter-bank lending markets have been successful and there are no imminent signs of the type of liquidity crisis that shook global credit markets in 2008.
We are forecasting that the Canadian economy will grow 2.4 per cent this year before bouncing up to 2.7 per cent in 2013. Slightly above trend growth in the economy and a narrowing Canadian output gap will put some upward pressure on inflation, though weakening global demand may lead to an offsetting adjustment in commodity prices. Overall we anticipate that inflation will remain well anchored to 2 per cent.
Interest Rate Outlook
Following the Bank of Canada’s April meeting, market expectations were beginning to align with the Bank of Canada’s preferred path of the short-term interest rate, as implied by its forecast for growth and inflation.
Since then, a wave of risk aversion and heightened anxiety over the Euro-crisis has sent Canadian bond yields plummeting and market expectations for Bank of Canada rate increases have sharply reversed course.
In April, the Bank suggested that the Euro-crisis had moved from an acute to chronic phase. While this turned out to be a misdiagnosis, it does suggest that a sense of stability, if not definitive resolution of the Euro-crisis, may be enough for the Bank to begin tightening policy.
At this point, with policymakers and politicians in Europe still struggling to put out a number of fires, it is difficult to see a stable Europe on the horizon. It is therefore increasingly unlikely that the Bank will begin raising interest rates in late 2012, though it has certainly left that door open if growth and inflation accelerate in the second half of the year.
Copyright British Columbia Real Estate Association. Reprinted with permission