Mortgage Rate Forecast

The June issue of Mortgage Rate Forecast is now available.

Highlights:

• Long-term interest rates spike from historic lows
• Canadian economy off to a better than expected start
• Bank of Canada – New boss, same policy

Mortgage Rate Outlook

The Canadian five-year posted mortgage rate once again fell back to its historical low of 5.14 per cent in the second quarter, its lowest level since early 2012. The decline in fixed mortgage rates followed an equally historic dive in five-year Canadian bond yields, which reached an all-time low of 1.15 per cent in May. Indeed, rates across the long-end of the Canadian yield curve swooned in the second quarter but have since spiked sharply back to where they were to start the year.

Historically low funding costs for Canadian banks translated to deep discounting of mortgage rates for home buyers with most lenders offering five-year fixed mortgages equal to the prime rate of just 3 per cent. In fact, and in spite of attempts by some policymakers at discouraging lower rates, some lenders continue to advertise fixed-rate mortgages at well below prime. However, depending on the sustainability of the recent rise in interest rates, those discounts may become scarce. It is difficult to cite a definite cause for the recent rise in interest rates, and much of the rise in Canadian interest rates may have more to do with what is going on in the United States than in the domestic economy. 

Generally, rising medium and long-term interest rates result from one of three scenarios. Markets may be concerned about government debt burdens and therefore demand higher interest rates. In addition, comments by central bankers may drive the market to perceive a more hawkish stance for monetary policy, which would push long rates higher. Finally, markets may be pricing in a more positive global economic outlook and therefore a return to a more normal shaped yield curve. Each of these scenarios implies a mix of different behaviours in asset markets.

There are other factors at work, but given recent trends in equity, bond and currency markets in the United States, the recent rise in interest rates is likely being driven by expectations of a stronger US economic recovery. 

Regardless of the root cause of higher rates, given where yields currently stand, we anticipate a modest increase in the five-year fixed-rate back to 5.24 per cent with the possibility of a further move up to 5.44 per cent if five-year yields continue to rise. As for one-year fixed rates, we expect very little, if any, movement over the next year and a half. 

Economic Outlook

Canadian economic growth was stronger than anticipated during the first quarter of 2013, expanding by 2.5 per cent. While growth surprised to the high side in the first quarter, we expect the remainder of the year to be modest, with the Canadian economy ultimately growing just 1.7 per cent this year. Going forward, we anticipate that a cooling of residential construction, lower household spending and restrained government budgets will challenge the economy. It is therefore imperative that the economy pivots towards export and business investment driven growth. On the export side, growth is highly contingent on a resurgent US economy where an economic recovery seems to be finding its footing in spite of recent forays into austerity. A lift in Canadian exports resulting from a stronger US economy should also improve business confidence and push investment higher.

Our forecast is currently in-line with that of the Bank of Canada, which means that the economy will return to full capacity some time in 2015. As economic growth accelerates, inflation should shift from its current low trend back onto a path to the Bank’s 2 per cent target.

Interest Rate Outlook 

The Bank of Canada welcomes a new Governor this month but remains in the status quo, caught between the rock of a somewhat muddling economy and the hard place of mounting household debt. In spite of inflation falling near the bottom of the Bank’s 1 to 3 per cent target range, its most recent interest rate announcement reaffirmed the Bank’s bias for higher interest rates, once again noting that current monetary stimulus would be appropriate for an ambiguous “period of time.” 

Our forecast for the Canadian output gap, like that of the Bank, implies that the economy will return to full capacity sometime in 2015, with inflation gradually returning to its 2 per cent target. As inflation returns to its target path, the Bank will begin to withdraw some of its current monetary stimulus. Our modelling suggests interest rates rising 25 basis points sometime in early 2015, if not late 2014.

Copyright BCREA - Reprinted with permission