At the end of April, the borrowing cost for a five-year fixed rate mortgage was 6.99 per cent, 55 basis points (bps) below year-end 2007. BCREA expects rates to remain stable over the second and third quarters of 2008 before rising modestly in Q4 2008 and into 2009.
US Weakness Impacts Canada
Lower interest rates are being driven by the faltering economy south of the border. The US is in the middle of a housing market-led economic downturn; housing starts are at the lowest levels since the early 1990s. Meanwhile, aggregate US resale home prices have dropped and unemployment rates have risen, contributing to lower consumer confidence, spending and greater economic uncertainty.
In response, the US Federal Reserve slashed its policy interest rate by 200 bps thus far in 2008, pushing it down to 2.25 per cent. Despite these efforts, US growth looks to remain weak for much of 2008 and into 2009.
A potential US recession will weigh on Canadian economic growth through various channels. Canada’s export sector, already reeling from the rapid ascent of the Canadian dollar in 2007, will be further challenged by reduced product demand. Undoubtedly, US weakness will flow through Canada’s economy, given that more than 78 per cent of Canadian goods exports are sent to the US.
Canada’s economy grew by only 0.8 per cent in Q4 2007, the lowest growth since Q2 of 2003. While domestic demand remained robust, export activity fell by 2.2 per cent over the previous quarter. Declines were mostly confined to the manufacturing, other goods and transport sectors, which depend more on cross-border trade.
Interest Rates to Fall
The Bank of Canada’s (BoC) mandate is to maintain price stability, rather than to explicitly target economic growth. That said, current and expected economic activity play critical roles in future inflation pressures and monetary policy. Core inflation was 1.3 per cent in March, marking the lowest growth since March 2004. The increased value of the Canadian dollar vis-à-vis the US has lowered import prices, and consumers have further benefited from the recent GST cut. Low inflation and a weak US economy point to further cuts in the BoC’s policy rate at future meetings this year.
Mortgage Rates
Cuts in the overnight rate directly impact variable mortgage rates, which are tied to prime rates. Prime rates adjust when the BoC adjusts its target for the overnight rate. In the fixed-rate mortgage market, rates are highly correlated to bond yields of similar maturity. While short-term rates partially filter into longer-term rates, future expectations for the economy, inflation and interest rates play larger roles. With the economy likely to remain weaker for much of 2008, inflation is likely to stay well anchored. As a result, the expectation of lower interest rates moving forward should dampen bond yields and lead to downward pressure on administered one and five year mortgage rates. However, continued volatility in financial markets has also translated into higher costs of credit for banks used for lending purposes. This should offset some of the downward pressure on mortgage rates.
“Copyright British Columbia Real Estate Association. Reprinted with permission.”
