The Prime Rate in Canada just increased, you are wondering what this means for your mortgage, we think it’s time for an analogy.
Let’s pretend the Canadian and American economies are cars. Our Central Banks (The Bank of Canada and the Federal Reserve) are driving the cars. The main job of the drivers is to make sure that we are always going at about the same speed without having to step on the gas or brakes too much. That speed is inflation, and the target is 2%.
Let’s add some complexity now. Unfortunately visibility on the road is not great. In addition the Central Bank doesn’t really know exactly how fast it is going at any given moment, and whether or not it is speeding up or slowing down. The drivers need to rely on data from a few months ago to tell if they should hit the gas or the brakes. Central Banks use different tools to try to best decide what to do, but they can never be certain about the outcome. The speed the car is going and whether it is accelerating or decelerating is affected by far more than just applying the gas or the brakes. These factors are largely out of the immediate control of the bank. So, the Bank needs to try to make predictions as to the acceleration of the car based on studying what might affect its speed in the next few kilometers and what historically has caused the car to go faster or slower. Upcoming hill? Heavy head winds? Do we need to stop for gas? Sound complicated? It is!
In the car analogy I mention that our Central Bankers rely heavily on different data points. The Bank of Canada is closely monitoring our countries Output Gap. This is the difference between what an economy is producing and what it can produce. The argument is that when an economy is in perfect balance it is producing goods at the most effective rate possible. Usually an economy is either producing goods inefficiently because it is spending too much to produce an increased number of goods, or because demand is low and it is not effectively putting its resources to work. The Bank of Canada (BoC) believes that we are closing the Output Gap and that we risk inefficiently producing in order to meet demand if we continue to keep our rates so low. As a result yesterday our Overnight Rate and therefore your variable rate mortgage increased by 0.25%.
If you are in a Variable Rate Mortgage you are probably wondering what you should do.
In order of importance here are the reasons why I think you should stay in a Variable Rate Mortgage.
- The Bond Market thinks the Bank of Canada is wrong.
This is by far the strongest piece of evidence that should tell Canadians that the market is not sold on the merits of the recent rate hike. The 30 year Government of Canada Bond Yield has actually decreased with this rate hike. Have a look here. The Bond market is saying that the combination of increasing the overnight rate with low underlying inflation will cause the BoC to cut rates again in the future.
- We aren’t really watching inflation
I fully understand the importance of the Output Gap. I trust in the BoC’s assertion that there are economic data points more forward looking than the inflation numbers, but we must keep in mind that inflation is currently at 1.3%, well below the 2% target. Yesterday the American Federal Reserve came out and said that perhaps some of the factors weighing against their country’s inflation might be more persistent structural changes that they hadn’t fully accounted for in previous rate hikes. So should we in Canada not be a little more careful when our neighbours to the South, who are in a similar economic growth conundrum, encounter problems properly predicting their inflation?
- New Borrowing Landscape
The Bank of Canada might not be taking into consideration just how much the new mortgage rules are affecting the economy. It is much harder to borrow money now than it has been in the 15 years that I have been in the mortgage business. Relatively speaking, borrowers are paying higher rates and getting less money than expected as a result of the rule changes.
- The longer Inflation stays low, the harder it is to actually stimulate growth.
This is an economic argument that states an economy that has had low inflation for a prolonged period of time will take longer to stimulate inflation. Remember we haven’t increased rates in 7 years!
- Housing Prices
The full impact of the recent regulatory changes has yet to be quantified in the red hot housing markets of Toronto and Vancouver. A sudden drop in values will likely lead to an acceleration in the decrease in house prices. This happens as the market greed turns to fear and weary homeowners and investor jettison properties that they probably shouldn’t have bought.
- Stronger Canadian Dollar
The Canadian dollar has strengthened by 4 cents in less than 1 month! Anyone who doesn’t think this will have a pronounced effect on our economy isn’t fit to get behind the wheel of a car.
- Oil is below the BoC’s target
The BoC has been using a target oil price between $50 and $55, and oil is currently trading at $46. With half of our country heavily reliant on the price of oil we need to be careful to fully recognize the impact of lower oil prices.
If you or someone you know would like a more detailed analysis of your mortgage and how you should prepare for the future please do not hesitate to contact one of our salaried mortgage agents, who will be more than happy to provide you with the sound, unbiased mortgage advice Canadians have come to expect from MorCan Direct.