2016 has been a time of small gains for the economy, though major challenges remain – a fact the Bank of Canada (BoC) acknowledged this week when it opted to leave its trend-setting overnight lending rate at 0.5%, where it has remained since July 2015.
Depressed oil prices will continue to be a main “drag on the economy”, this year and next, prompting the BoC to take a steady hand with monetary policy. While improvements to manufacturing and exports boosted Q1 GDP by a surprising 0.6%, it’s too little too late, with further cuts expected for the oil industry.
“First-quarter GDP growth appears to have been unexpectedly strong, but some of that strength is due to temporary factors and is likely to reverse in the second quarter,” the BoC states in its release. “Still, it does appear that the positive forces at work in the economy are starting to outweigh those that are negative.”
Inflation, while tracking as the BoC expected, is below its 2% target, and is expected to drop further due to the Canadian exchange rate and lower energy prices, before reaching normal capacity.
The Gift of Growth
The BoC concedes that current conditions would have led them to slash their 2016 growth forecast had it not been for the massive spending initiatives promised by the Liberal government. In the March federal budget, the Liberals revealed a $120-billion stimulus plan for new infrastructure and social projects.
The BoC has found the spending will have a “notable” positive impact on GDP and calls for 1.7% improvement this year (up from the January forecast of 1.4%), 2.3% in 2017, and 2% in 2018. States the Bank, “This new growth profile, combined with the revised estimate for potential, suggests the output gap could close somewhat earlier than the Bank had anticipated in January, likely in the second half of 2017.”
The Dollar Balancing Act
The state of the Canadian dollar is carefully considered in the BoC’s decision-making; cutting interest rates would put further downward pressure on the loonie, which has dropped 25% since 2012.
While a weak dollar is beneficial to economic recovery – exports get a boost as Canadian goods become more attractively priced – slashing the cost of borrowing further would further encourage risky consumer borrowing. The Canadian debt-to-income ratio hit 165% - a new high – last month, due to record-low borrowing costs.
However, it appears hiking rates is off the table until at least 2017; not only would that push the loonie higher, but could lead to a rash of defaults, as mortgage and loan borrowers find themselves unable to afford their payments.
What About Your Mortgage?
No change from our central bank means current variable mortgage rates will stay put – if you’re currently a variable mortgage holder, you can expect your payments to remain stable in the medium term.
Fixed mortgage rates, while not directly mandated by the Bank of Canada, will also remain competitively priced. Bond investors, attracted by prolonged loose monetary policy, will keep bond yields, and fixed rates, low, and lenders typically introduce their best pricing of their year at this time, with brokers offering five-year fixed rates as low as 2.30%, and BMO leading the big banks with a flashy 2.59%.
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The next Bank of Canada interest rate announcement is scheduled for May 25, 2016.