We live in interesting times, as the Chinese proverb goes. The presidential election in the United States shows us the ripple effect that can occur when our neighbours to the south do something a little different with policies and rules.
While the Bank of Canada sometimes follows as the U.S. leads, other times it does not. When the U.S. Federal Reserve raised interest rates recently (Dec. 14, 2016 and again in March 2017) the Bank of Canada did not raise rates. Recently the Fed raised its interest rate by 0.25 per cent so that it now stands at 1.0 per cent. The plan is for it to be raised again in 2017 until a 1.4 per cent interest rate is achieved. The Bank of Canada’s current interest rate is 0.5 per cent and it is likely to stay there in the near future.
The Bank of Canada’s key interest rate is a target rate used by banks to set the prime rate. This determines what your base interest rate will be when borrowing money. Factors such as your credit may increase your interest rate, but the base rate of interest your bank begins with in calculating your interest starts from its prime rate. Since this rate is re-evaluated and sometimes re-set eight times every year, each change can influence future borrowing and current variable rate borrowing.
We know that the U.S. and Canada generally move in the same directions with monetary policies. Canada has been divergent from the usual for a few months, while other countries are also trending toward the divergence of monetary policies. For instance, the Fed kept its policy rate near zero for the past seven years, the European Central Bank cut its rate to negative 0.3 per cent and Canada cut its rate in late 2016. The central banks are following policy that assists their country’s own economies.
Governor Stephen Poloz of the Bank of Canada says he believes divergence patterns will be around for a while. While the U.S. economy is picking up, Canada is remaining stagnant. Higher interest rates are therefore are not in the cards at the moment.
When the Fed raises interest rates, the loonie becomes weaker. To augment that, the Bank of Canada may keep interest rates low, as they have most recently. Our oil prices have a strong effect on the Canadian dollar as well and sometimes higher oil prices buffer a weak loonie. Good for some sectors, bad for others. Tourism goes up with a weak loonie, while prices of things like groceries usually go up. U.S. equity investments will rise.
In real estate, a lower loonie can also translate into more foreign buyers hitting the hot markets.
Fixed-rate mortgages are linked to 10-year bond yields. A rise in bond rates will begin to increase fixed-rate mortgage rates. That is because fixed-rate loans can feel the pressure from inflation, market fluctuation and investor sentiment. Bond markets can move faster than the prime rate. A negative scenario for mortgage buyers, for instance, is when the market does not like a series of factors such as divergent money policy, slow global economic growth, an aging global population and even who is elected president or prime minister of key influential countries.
Variable rates are less likely to change in the current market. Although the Fed influences these rates too, it is U.S. variable rate mortgage holders along with credit card, auto loan and line of credit users who will feel the pain first. Higher loans can also decrease business spending along the line and affect the stock market, through sectors such as financial holdings when there is a rate hike.
While this is a simplification, it is a good reminder that whether your clients get a fixed or variable rate mortgage, be sure it is something they are comfortable paying back. For consumers, continuing to watch both the Federal Reserve and Bank of Canada are prudent steps when thinking of a mortgage. The increasing interest rate at the Fed will eventually increase borrowing costs across the board, which trickles down to similar increases for Canadian borrowing costs.
Yvonne Dick is a contributing writer for REM with two decades of experience in journalism.
