Variable Rate May No Longer Win

Garry Marr, Financial Post · Tuesday, Jul. 27, 2010

Not that there are a lot of people buying houses these days, but the answer to the age-old question of whether to go long or short on your mortgage is unclear yet again.

The Bank of Canada’s second quarter-of-a-point rate increase in the past two months is likely not going to do much to boost a real estate market that saw sales drop almost 20% across the country in June from a year ago.

The popular variable-rate product tied to prime that helped people buy a lot more house with more debt is going up too. The prime rate at the major banks, which tracks the Bank of Canada’s rate, is now at 2.75%.

But a funny thing happened as the Bank of Canada was raising rates. With much of the credit crisis seemingly behind us, the discounts on short-term borrowing are increasing as the cost of funds for banks also fall. Instead of borrowing at 100 basis points above prime, it’s now 70 basis points off prime.

At 2.05%, a variable-rate product today may look as attractive as ever, but the five-year fixed-rate closed mortgage is falling fast. It can now be had for a shade under 4%, says Rob McLister, editor of Canadian Mortgage Trends.

“Bond yields have fallen out of bed and nobody expected that,” said Mr. McLister, adding the spread between the five-year Government of Canada bonds and five-year mortgages is still large enough that the banks may reduce long-term rates even more. However, at about 4%, the five-year closed fixed-rate mortgage isn’t far off its record low.

Bank of Montreal senior economist Sal Guatieri does agree that variable-rate products have worked out better than fixed-rate mortgages throughout history, but says the tide may be turning.

“Given that the central bank has already raised rates a couple of times now and will likely continue to raise rates, it probably is a correct assumption to make,” says Mr. Guatieri, noting variable usually works in a declining interest-rate environment. “The next five years might not quite follow the past. You could probably argue it’s wiser to lock in now. It’s a close call.”

Bank of Montreal is forecasting another 25 basis point move in September and says rates will climb another 1.5 percentage points by the end of 2011. If Mr. Guatieri and others are right, by 2012, the variable-rate products out today would clock in at just above 3.75%, if the discounting remains the same.

“If you are still in that variable-rate product then, you’d have to sweat out the next three years because there would still be possibly more increases,” says Mr. Guatieri, who adds his bank sees the overnight rate eventually going to 4% in the following three years. Based on the present gap between the Bank of Canada and prime, that would place the variable-rate product you get today at 6% by around 2015.

Fears of such a scenario are driving people into fixed-rate products again. That, plus new mortgage rules that make it easier to qualify for a mortgage if you go for a fixed-rate product with a term of five years or longer.

“The Bank of Canada is doing what it said — it’s going ahead with rate increases. If I was counselling someone, the prediction is rates are going up, so now is a good time to consider locking in for a term,” says Don Lawby, president of Century 21 Canada.

It makes sense, but with variable rate still at around 2%, it’s easy to see why people wouldn’t want to lock in. Even Mr. Guatieri says if you are secure in your financial situation and don’t need to fix your mortgage payments, “you might just want to let it ride.”

There just never seems to be a clear answer on whether to lock in or stay variable.

Read more: http://www.financialpost.com/news/Variable+rate+longer/3329442/story.html#ixzz0vSziPq1z

Variable Rate May No Longer Win

Friday's Inflation Rate Expected to Open Door to Interest Rate Hikes: Economists.

By Julian Beltrame, The Canadian Press

OTTAWA - Canadians likely have only two weeks left to enjoy historically low interest rates.

With global markets beginning to stabilize following the recent fears over a Greek debt default, economists say the pieces are falling into place for the Bank of Canada to move off its emergency 0.25 per cent rate on June 1.

Economists — and markets — have already pencilled in a doubling of the policy rate in two weeks. But that is only a beginning say analysts who believe governor Mark Carney will keep on hiking rates through the rest of the year.

Even the TD Bank, which only a few months ago was advising Carney to wait until at least the third quarter of 2010, is now calling for an incremental hike beginning in June.

The reason, says the bank's director of forecasting Beata Caranci, is that the Canadian economic recovery is well ahead of schedule with what looks like two consecutive quarters of five per cent and beyond growth, a jobs recovery more robust than predicted with another 109,000 added in April, and inflation — the key indicator for the central bank — heading toward two per cent.

"The bank is looking a year or year-and-a-half out, and they are looking at an output gap that is not going to be there anymore, so they've got to start adjusting now to get the interest rate at what would be considered more neutral," she explained.

"And if they don't go now, it could mean we see bigger adjustments down the road," she added.

Higher rates are meant to slow down excessive borrowing and head off asset bubbles like an overheated housing market, which the central bank has already highlighted as a risk. Cheap money is also seen as destabilizing in the long term, much as happened in the United States in the early part of the decade and eventually led to the most recent crisis.

Economists caution that the anticipated hikes by the central bank should not be seen as an attempt to slow down activity, but merely as moving to a more traditional posture. With inflation at near two per cent, the current 0.25 per cent level is actually a negative interest rate, they note.

The TD Bank and many others believe Canada's policy rate will hit 1.5 per cent by year's end, more in line with inflation.

Carney gave a strong hint last month that he was preparing to move, surprising observers by dropping his year-long conditional pledge not to hike rates until at least July.

He has since added an element of doubt into expectations by noting that he considered the very act of removing the conditional commitment to have been a policy tightening measure. The rate-hiking narrative took another detour earlier this month with the recent turmoil in equity and financial markets over government debt issues in southern Europe — that added new uncertainty to the global recovery scenario.

But unless Europe again flares up in a major way, the only question remaining for Carney will likely be answered Friday with the release of April inflation data by Statistics Canada, say economists.

The consensus is that headline inflation will rise to 1.6 per cent and core underlying inflation — the index the central bank closely watches — will edge up to 1.8 per cent.

Those numbers are still below the bank's two per cent target but economists say they are worried because inflation is digging in at a time when the economy is still operating far below capacity, and at a time when the Canadian dollar is near parity.

That is not the case in the U.S., where inflation is actually heading south and could once again approach zero by year's end.

"Even with the current volatility in financial markets, the Canadian story remains intact as underlying fundamentals continue to improve alongside strong corporate and household balance sheets," write Scotiabank economists Derek Holt and Karen Cordes Woods in forecasting an interest rate hike.

Bank of Montreal economist Douglas Porter says there is still a chance Carney will wait until July 20, or even later, especially if the European crisis threatens to leak into North American credit markets, or if there's a big downward surprise in underlying inflation Friday.

Increasing rates in Canada, especially since the U.S. is likely to keep its policy rate at zero until 2011, will put added upward pressure on the Canadian dollar, which will further depress the country's manufacturing and exporting sectors.

But Caranci believes the dollar impact will be minor, because markets have already priced in several moves by Carney ahead of the U.S. And the loonie's recent dip below parity to about 96 cents US has partly removed an important impediment to act on rates for the Bank of Canada, she adds.

Friday's Inflation Rate Expected to Open Door to Interest Rate Hikes: Economists.

Bank of Canada Holds Rate

The Bank of Canada on Tuesday held the overnight rate at 0.25% following its commitment to keep rates down through the end of June 2010. The Bank of Canada remained optimistic for the performance of the economy in the second half of 2009, it seemed to be pessimistic on the medium term outlook for the Canadian economy. The bank stated the stronger performance in the second half of 2009 will be driven by "monetary and fiscal stimulus, increased household wealth, improving financial conditions, higher commodity prices, and stronger business and consumer confidence". However, the negative impact from the strength of the Loonie on the export market will more than offset these improvements and therefore the Bank has lowered its growth projection for 2011 to 3.3% down from 3.5%. The Bank now anticipates the economy will reach full capacity and inflation will reach the Bank's target by the end of June 2011, one quarter later than in the July MPR. The Bank of Canada feels the risks to the "inflation projection are tilted to the downside."

This announcement laid to rest some speculation that the bank would follow Australia' lead and hike rates sooner than expected. Canada like Australia's economic growth is being helped by commodity markets but unlike Australia, Canada suffered a deep, short recession led by the US. The Bank of Canada wants to ensure that Canada is in a recovery before hiking rates too soon. The outlook for the Canada's economy has improved significantly since the last rate announcement date but the soft domestic demand has kept inflation well under the 2% target.

Some economists believe the Bank of Canada will keep rates steady to the fourth quarter of next year but this only a prediction. Variable rate mortgages will be the best option for clients, at least for the next year or more.

Bank of Canada Holds Rate