MORTGAGE REGULATIONS GO BACK IN TIME

Mortgage Rate Outlook

The biggest change to the mortgage market this year had nothing to do with mortgage rates, but rather with further changes to mortgage regulations. In June, the federal government announced a number of new regulations for the Canadian mortgage market, the most important of which was reducing the maximum insurable mortgage amortization period from 30 years to 25 years.

In lowering amortization from 30 years back to 25 years (the prevailing amortization period in 2004) the government has now completely undone its prior, and probably misguided, forays into the mortgage market. The change from 30 years to 25 year amortizations will have a fairly significant impact on monthly mortgage costs, similar to the impact of roughly 1 per cent increase in mortgage rates.

In order to offset the impact on consumer demand from stricter mortgage regulations, Banks and other lenders will likely keep mortgage rates low with perhaps more competitive discounting for homebuyers with strong credit histories. Moreover, ongoing uncertainty in the global economy will translate into a persistence of very low Canadian bond yields.

We forecast that the posted five-year mortgage rate will remain at 5.24 per cent for the balance of 2012 before gradually rising in 2013 to 5.85. Little change is expected to the 1-year rate over the next six months at 3.1 per cent, but it is expected to rise when the Bank of Canada raises interest rates in early to mid-2013.

 

Economic Outlook

Canadian economic growth remains challenged by a difficult global economy and lacklustre growth in the United States. Export growth through the first half of 2012 slowed and the overall trade balance (exports minus imports) was a drag on GDP for two consecutive quarters.

Moreover, there are signs that Canadian consumers are starting to slow their purchases due to modest job growth and elevated household debt. The accumulation of household debt in recent years, when combined with higher interest rates in the future, may cause a significant amount of consumer deleveraging over the medium-term. This will mean lower levels of consumer spending, particularly spending financed through home-equity loans and other forms of consumer credit. The Bank of Canada has estimated the required consumer deleveraging at nearly $50 billion or close to 3 per cent of Canadian GDP.

If such deleveraging is to take place, the burden of economic growth will need to shift from consumers to exporters and Canadian businesses in order to fill the gap left by a slower rate of consumer spending. While a slower rate of consumption will act as a drag on growth, the consequent reduction in household debt means that the economy should emerge even stronger and less vulnerable to external shocks. We forecast that growth in the Canadian economy will remain modest over the next two years, expanding 2 per cent this year and 2.2 per cent in 2013.

 

Interest Rate Outlook

The Bank of Canada remains caught in a delicate balancing act. The trajectory of the output gap and the stickiness of consumer prices would under normal conditions, and under conventional monetary economics (see adjacent chart), have pushed the Bank towards tightening interest rates. However, potential interest rate increases have been deferred by a near crisis environment in Europe, a stop-and-go US economy, and perhaps most importantly, the highly indebted position of Canadian households.

A slowing global economy and a high dollar continue to exert pressure on Canadian exporters. Furthermore, while the Bank has carefully communicated that US monetary policy will not determine Bank of Canada rate actions, the explicit stance of the US Federal Reserve to keep interest rates low past 2014 does somewhat constrain the Bank’s ability to raise interest rates without putting further upward pressure on the loonie and harming much needed export growth.

In terms of the domestic economy, the Bank has been consistently exhorting Canadian businesses to spend and households to save. In a best-case scenario, consumers would be deleveraging while businesses invested in productivity enhancing capital. This would facilitate a necessary shifting of the burden of growth from consumers to Canadian firms.

A scenario of consumer deleveraging paired with ramped-up business investment and export growth will require interest rates to remain low. That said, the Bank is also serious about maintaining its mandate of price stability and is increasingly indicating a desire to move rates off of historically low levels. Balancing these objectives will require a delicate fine-tuning of monetary policy which we expect to proceed cautiously, perhaps with a rate-tightening of 25 to 50 basis points beginning in early to mid-2013. This slight increase in interest rates would allow the Bank to signal to households that higher interest rates are on the horizon while still maintaining a substantial degree of monetary stimulus to encourage business investment.

Copyright BCREA Reprinted with permission