Why Bank of Canada is leaving rates alone
There has been alot of talk recently about the Bank of Canada and whether or not they should start raining interest rates. As the news we are hearing is starting to become more positive (strong Canadian dollar, Stock market rallies, Recession is over…etc), some are suggesting the Bank of Canada is going to start raising rates in order to keep the Canadian economy from experiencing extreme inflation. For those of you that read my site to keep on top of recent rates and pick up a few homebuying tips…..you can probably stop reading now. But for those of you that are interest to hear why interest rates and the economy are so closely linked, keep on reading.
There was recently an article in the Globe and Mail that summarized this topic nicely so I thought I would talk about some of the main points in the article. As you will see, the Bank of Canada has quite a few good reasons why they are still holding to their promise to keep the prime lending rate where it is until next summer.
Borrowing is still weak - Although interest rates are at all time lows, the demand for money is still weak. In the US, consumers are trying to pay off the debt they already have and not looking to take on any new debt. In Canada, consumers are still borrowing (although not as much as in the past), but business borrowing is still way down. The Bank of Canada lowered the interest rate in order to encourage people and business to borrow money to spend in the economy and spur growth, but this may not be generating the growth they hoped for.
Leverage still largely absent – This is most visible in mortgage lending and is the basically the percentage of the purchase price of a home that is being financed with debt. After the crash a couple of years ago we saw lenders in the US and Canada tighten up their guidelines around how much downpayment individuals needed to buy a home. Both countries are still seeing an increase in the amount of money people are using as downpayments. In short they are borrowing less and bringing more of their own equity to the table. If you ask me this is not a bad thing.
Only broad based inflation would justify a rate hike - We are seeing certain parts of the economy begin to recover (and grow in some cases), but as a whole the economy is still moving slowly. Until the Bank of Canada sees widespread evidence of inflation they will hold rates constant. A premature raising of interest rates could do significant damage to an already damaged economy.
Rate increase would strengthen an already high Loonie – Canada’s currency has seen a significant increase in the last 6 months and currently is almost at par with the US Dollar. Although this is great for consumers who want to do some cross border shopping, it makes our products relatively expensive on the world stage which leads to a drop in demand and ultimately exports. If the Bank of Canada were to raise rates it would result in our currency increasing in value even further which could be devastating to Canadian manufacturers, cause more lay-offs and prolong or sluggish economy.
So how does all of this tie into mortgages? Well, the longer the Bank of Canada keeps the prime lending rate where it is, the longer consumers can enjoy their extremely low variable rates. if you do have a variable rate mortgage I would advise paying down as much as you can possibly afford now so when rates go back up you are paying interest on a much lower principal amount.
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