Variable-rate borrowers across the country are waiting for the Bank of Canada’s (BoC) rate decision tomorrow. The market is starving for any clues on interest rate direction.
Analysts are now increasingly predicting the Bank will be compelled to cut rates this year. Lower rates are necessary, they argue, as insurance against growing global instability. That’s despite a domestic economy that still has spring in its step
But the chances of a drop tomorrow are small, according to investors. The BoC is widely expected to leave its overnight rate unchanged at 1.75%.
Next month is a different story. Markets are pricing in a 56% chance the bank will cut rates at the following meeting on October 30. That’s up from 32% in July, according to Westpac.
“The market now expects two full cuts over the next 18 months, compared to our expectation of three cuts by early next year,” wrote Stephen Brown, senior Canada economist at Capital Economics. “Investors don’t think the Bank will be ready to act in September, however.”
Brown noted that domestic data alone doesn’t yet justify a rate cut. He points to inflation being on target in July, a 4.5% year-over-year jump in wage growth and a healthy GDP expansion of 3.1% in the second quarter.
“This will give policy-makers pause for thought and explains why markets are pricing in a less than 20% chance of a rate cut at the meeting (tomorrow),” Brown wrote. “But Canada’s position as a small, open economy means there is little prospect of the country getting through the global slowdown unscathed.”
Canada’s economic fundamentals have been relatively positive—or at least stable—in recent months, but that could be about to change.
Last week’s quarterly GDP report may be the first example. Despite beating expectations for overall growth, the underlying details were less impressive.
TD Bank economist Brian DePratto pointed out that a surge in trade was largely due to a spike in May that is no longer showing up in monthly data, while domestic demand has contracted for three of the last four quarters.
“Not only were (the GDP) details weak, but since the second quarter ended we've seen yet another escalation in the trade wars and associated uncertainty, alongside further weakness in the global growth backdrop and commodity prices,” DePratto wrote in a research note. “The rear-view mirror may be showing a rebound of growth, but the road ahead continues to crumble.”
Whether the BoC drops its overnight target rate by 25 basis points this week, next month, or in December, chances are high a cut is coming before an increase.
So how would that affect your mortgage loan?
It won’t if you have a fixed-rate mortgage, at least for the term of your mortgage. If you renew in the next year or so, however, the market implies there’s a fair chance fixed rates could be lower than they are today.
Tip: Don’t over-rely on such rate speculation because the inflation outlook could change next quarter, let alone next year.
If you’re riding out a variable-rate (a.k.a. floating-rate) mortgage, a Bank of Canada rate cut—and subsequent fall in the prime rate—could affect you in one of two ways:
1) Your monthly payments could drop: This would be the case only if you have an adjustable rate, meaning that your monthly payment rises or falls as the BoC raises or lowers its key rate.
For example: Let’s assume you have a $300,000 mortgage, 20-year amortization and a five-year adjustable rate of 2.90%, or prime – 1.05%. If the BoC cuts rates by 25 bps and the big banks lower their prime rates by a corresponding amount (a big question mark), your new rate will fall to 2.65%, also prime – 1.05%.
Old monthly payment: $1,646
New monthly payment: $1,610
Savings: $36 per month
Or…
2) Your principal-to-interest ratio could improve. This would happen if you have a variable mortgage with a fixed payment. In this case, your payment would remain the same, despite a falling prime rate. But the amount going towards principal would increase, meaning you’d be charged less interest.
If you’re curious, here’s a list of lenders who offer fixed-payment variable mortgages.