On Tuesday,  the Bank of Canada left the Prime rate unchanged for the 13^th consecutive meeting.   Mark Carney, the Governor of the Bank of Canada, used this meeting to hint at rate increases coming quicker than most might expect.  It is hard to say whether he was just trying to change public and market behavior with his comments or if he actually intends to begin the process of increasing rates before the end of the year.  Although the recent positive job numbers, reduced potential harm from the European debt crisis, and an improving US economy all lead towards a greater potential for higher rates, the Bank of Canada is in between a rock and a hard place.   The mere mention of potential rate increases caused the Canadian dollar to jump over one cent the day the speech was made.

Carney is increasingly concerned over the household debt levels in Canada and has repeatedly stated that this may be the biggest risk to Canada’s economic prosperity.   The problem is that if rates increase, and they will eventually, then there are a significant number of households that will be in financial difficulty as they are unable to afford increased debt payments caused by higher interest rates.   By increasing the Prime rate, the hope is that households will reduce their debt in preparation for higher rates.    However, increasing the rate will also increase the value of the Canadian dollar which will reduce exports and slow the economy down.    The Canadian dollar is also considered to be a quasi- petro dollar.  This means that due to Canada being a major oil exporter, increases in the value of oil lead to an increase in the value of the Canadian dollar. 

The only thing we know for sure is that rates will normalize eventually, and a normal Prime rate would probably be somewhere between 5% and 6.5%.   This is obviously a dramatic increase but the factors above mean that the Bank of Canada will have to walk a fine line between discouraging household debt & curbing inflation by increasing rates versus allowing the economy to grow by leaving rates alone for a while.  I am still predicting that rates will increase by 2% to 3% over the next five years but the timing and pace of the expected increases is too hard to predict at this time.

 Jason McLean  BSc, AMP
jason@garibaldimortgage.com

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As European debt concerns continue to hang around, Greece is seemingly meeting new hurdles at every turn as they try to get more debt relief.   Like the boy that cried wolf, nobody really believes that Greece will be able to keep the austerity promises since their record on fiscal responsibility has been dubious at best.  Italy and Spain saw slightly increased bond yields, although not yet in the extreme danger zone, as the markets are once again showing concern that the debt crisis will spread further.

The increasing tensions about Iran is causing oil prices to increase as markets worry about potential supply shocks.  Although Iran produces around 5% of the world’s oil, the greater concern may lie in the chance of any conflicts spreading throughout the Middle East and disrupting supply channels.    Higher oil prices will cause a barrier to economic recovery as it represents a major cost for most industries.    Although this would initially keep interest rates low, any prolonged increase in oil prices would eventually result in higher inflation as the increased cost makes it way to the consumers of the end products.  Increasing inflation would lead to higher interest rates as the Bank of Canada would try to keep inflation in check by tightening the availability of cheap money. This situation with Iran is worth watching for the foreseeable future.

Some lenders began raising rates last week.  Most of the remaining lenders are increasing rates slightly this week.  Fixed rates are still extremely low and the current environment represents an excellent time to lock in borrowing costs for the long term.   

Since Monday is President’s Day for the US, please remember that for qualified US clients, financing is available at up to 80% (for the first $750k) at excellent rates.    The last few days have seen an increased volatility in the value of the Canadian dollar.  These movements in the dollar will provide opportunities for non-residents to purchase Canadian dollars at good value if the currency rates are watched closely.

Variable rates are still available at around Prime less 0.20% but for most clients, fixed rates are a much better choice since the spread between fixed and variable is so small.

 Jason McLean BSc, AMP
jason@garibaldimortgage.com 

Comment (32)

Increasing bond yields over the past week have led a couple of lenders to remove a couple of the super low rate products that were available last week.  However, there are still a number of tremendous rate deals available at the moment.   We may see relatively low rates hang around for a couple of years based on continuing negative projections for the global economy.  Wednesday, the US Federal Reserve indicated that they will not increase rates until the end of 2014 based on a lack of confidence in the US economy improving significantly before that date.   The markets showed that investors think that the Central Bank of Canada will raise rates prior to the end of 2014.   This was seen in the rise of the Canadian dollar which briefly went above par this morning.    Although the comments from the Federal Reserve are just projections, it does show that global markets have greater confidence in the future of the Canadian economy than the US economy.

The Federal Reserve also stated that additional stimulus measures may be required to improve growth prospects.  Since 2008, there have been large stimulus packages implemented worldwide as various countries tried to mitigate the economic consequences of the 2008 crash and subsequent credit crunch.  If stimulus measures continue to be implemented on a large scale, we may eventually see economic growth turn positive faster than without stimulus, but it come with the risk of rapid inflation.    With inflation we will see increases to interest rates.  This may not happen for 3 to 5 years but when it does, we may see rapid increases to interest rates.   This is the main reason that I am recommending a 10 year term to a number of clients that expect to hold their properties for the long term.

In Europe, Italy saw some improvement in the yields for their most recent bond sale.  Italy still has a tough road ahead but this is a step in the right direction.  Greece seems to be the weeble-wobble of the EU economy, just about falling over at every turn.   I think that it is just a matter of time before Greece defaults and goes belly up but just like the weeble-wobble, Greece seems to delay the inevitable at every turn.  Until something more concrete happens in Europe, starting with Greece, the uncertainty will prevent the solid policy change and that is required to move out of this mess.

Jason McLean   BSc, AMP
jason@garibaldimortgage.com 

Comment (33)

Markets around the world are up today after the progress that was made at the European Union debt meeting yesterday.   The agreements reached included getting private investors that hold Greek debt to take 50% of what they are owed (which they probably thought was better than the potential for zero if a deal was not reached); increasing capitalization requirements of banks to 9% (this makes the banks better able to withstand economic shocks and bad loans); and increasing the size of the emergency bailout fund for the EU and the European banks.  

Although this is really only the first step, it represents the most significant progress on this issue in months.     It does not mean that the problems have been entirely solved but it provides the markets with optimism that the debt contagion can be contained to a few countries within the EU.   If Greece can show some positive economic growth, which is going to be very difficult to do, then the financial lesion under this latest bandage may start to heal.

The positive European news, along with decent economic data out of the US this week, have pushed the Canadian dollar back over par.   Earlier this week, the dollar initially showed some strength on increased inflation for September, but quickly fell off again as the Bank of Canada reported concerns about sluggish growth prospects for the next year or two.   This continued volatility seems to be the new norm but it will provide opportunities for currency speculation for those who can act quickly.

All this good news will likely show up as increases in bond yields over the next few days.  Although the spread to the lenders is currently quite large, in times of volatility the lenders are being very cautious.  Therefore we may see some slight upwards pressure on fixed rates.  The best way to protect against this movement is for buyers to get  a rate hold.  With a rate hold, the client is not obligated to do anything but it is insurance against higher rates if the client closes on a deal in the following three to four months.  The best part is that this “insurance” is free!

Discounts on variable rates continue to evaporate and make fixed terms look more attractive.    The best term choice really depends on the situation of the individual client so feel free to ask about your situation.    One lender still has 3.29% 5 year rate for CMHC deals on regular, non-restricted properties (this works well for Pemberton) and another has 3.45% which is available for most owner-occupied properties in Whistler.   

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The latest jolt to the global economy came as Portugal’s credit rating was reduced to junk status.  This is another step, along the path to potential debt default, which has reduced market confidence in a number of the European economies.  Along with the usual suspects of Greece, Ireland and Spain; there have been rumblings about the high debt levels in Italy.    Although the economy of Germany is shouldering much of the load for the European Economic Union, there is a large potential for a decrease in the value of the Euro.   If the situation continues along this path, we may well see an increase in international clients purchasing assets in economic  safe havens such as Canada.   

US manufacturing numbers were up slightly in recent reports but this is probably a temporary effect resulting from increased costs of manufacturing in China.   Labor costs in China have increased substantially over the past year and China has just increased interest rates by another 0.25% to try and stem inflation.     The combination of increased costs and a relatively low US dollar has allowed US manufacturers to gain some ground recently but the end of stimulus funds will mitigate these gains over the next few months.   The US government will likely come to an agreement on maximum debt levels which should prevent significant investor flight from this traditional safe haven currency.

Despite recent increases to core inflation figures in Canada, GDP growth should be slower than anticipated.  The global economic uncertainty will likely prevent commodity prices from increasing substantially.  The Bank of Canada will likely raise the Prime rate by 0.25% in September but this may be the only increase in the rest of 2011.  Fixed rates should also stay relatively stable with five year fixed terms still available at under 4.25% by the end of the year.   Current five year terms are available at 3.74% for most Whistler properties.  Rate holds are recommended for clients considering a purchase in the next few months.  The Canadian dollar will remain above par for the foreseeable future, with pockets of volatility that should provide opportunities for currency speculators.    

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