Mortgage Rate Outlook
The current spread between fixed five-year mortgage rates
and five-year government bond yields remains well above historical norms.
Normally, this is suggestive of a coming decline in fixed rates. However,
elevated risk in global financial markets and a tightening of credit among
Canadian lenders reported in the most recent Bank of Canada Senior Loan Officer
Survey has translated to fixed rates remaining steady in spite of falling bond
yields.
Perhaps more importantly, US bond yields have risen in
recent months as the US economy accelerates and the US Federal Reserve prepares
to raise its target overnight for the first time since the 2008 financial
crisis. Canadian yields have so far diverged from those in the US, but
historically the correlation between the two is very strong, even when the two
countries’ normally in sync monetary policy is heading in different directions.
Therefore, whether the Fed opts to raise interest rates
this year or next, it will have a meaningful impact on bond yields in Canada.
In conjunction with what should be a recovering Canadian economy, we expect
there to be some upward pressure on fixed mortgage rates by the middle of next
year with five-year rates rising to just over 5 per cent.
Economic Outlook
The Canadian economy contracted in the second quarter of
2015, declining 0.5 per cent on an annualized basis following a 0.8 per cent
contraction in the first quarter. A second consecutive quarterly decline fits
what some call the technical or statutory definition of a recession.
While some may quibble over whether the economy was in
recession, technical or otherwise, economic growth was undeniably weak for the
first five months of the year. However, the downturn was quite modest compared
to the severe recessions of the early 1990s or the 2008 financial crisis.
Moreover, it appears from available third quarter data
that the economy is already rebounding and should post fairly robust growth for
the remainder of the year. We expect that the Canadian economy will eke out
growth of 1.1 per cent this year and 2.4 per cent growth next year.
Interest Rate Outlook
The Bank of Canada once again finds itself in a delicate
balancing act between supporting those regions of Canada adversely impacted by
low oil prices while not tipping the balance of risk in the economy toward
overly indebted Canadian households. Further complicating matters are the
realities of conducting monetary policy so close to the so called “zero lower
bound”. While in theory, the lower bound for interest rates is zero; in
practice, transaction costs associated with short-term money markets make 25
basis points as low as the Bank can go while preserving a functioning market.
With its target overnight rate at just 0.5 per cent, the Bank is risking
returning to its effective lower bound of 25 basis points for the second time
in six years. As monetary policy approaches that lower bound, it tends to get
more and more ineffective, particularly when the usual channels for monetary
policy to work, such as housing and consumer debt, are already somewhat clogged
by high Canadian debt levels. If traditional monetary policy were exhausted,
the Bank would have to resort to less conventional policies, including forward
guidance or quantitative easing, to achieve its inflation targeting mandate.
In the absence of a crisis inducing economic or financial
shock, the Bank would likely prefer not to test the lower bound on interest
rates and may even begin to tighten rates by the end of next year if the
economy resumes a healthy and sustainable rate of growth.
Copyright BCREA – reprinted with permission
