By Yvonne Dick from The Real Estate Magazine
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.
