Bank of Canada raises key interest rate a quarter point to one per cent

Bank of Canada raises key interest rate a quarter point to one per cent


Julian Beltrame, The Canadian Press
OTTAWA - The Bank of Canada raised the trend-setting interest rate a quarter point to one per cent on Wednesday, even as it acknowledged that the country's economic growth will be more gradual than previously thought.


It was the third hike in three months, taking the overnight rate up in stages from the rock-bottom 0.25 per cent that was set by the central bank during the recession to help stimulate the economy.

The hike, which most economists had predicted and supported, will likely have the effect of increasing borrowing costs on short-term loans, such as variable mortgages and lines of credit.

The Canadian dollar got an immediate boost following the announcement, rising 1.11 cents to 96.53 cents US.








Analysts had been looking for acknowledgment from bank governor Mark Carney that the recovery has taken a few surprise body blows of late and that he will now pause for the next few months until the picture clears.

Instead, the bank's governing council appeared content to stick to its previously optimistic outlook and gave no hint about plans for future decisions, saying that will depend on the "unusual uncertainty" of the outlook.

The council remained upbeat on the economy, downplaying its overly optimistic April and July forecasts.

"Economic activity in Canada was slightly softer in the second quarter than the bank had expected, although consumption and investment have evolved largely as anticipated," the council wrote.

"Going forward, consumption growth is expected to remain solid and business investment to rise strongly."

The tone of the central bank's statement was "a bit more hawkish than we expected," said Bank of Montreal economist Douglas Porter.

"The Bank of Canada clearly retains its tightening bias and seems generally unfazed by the recent cooling in the Canadian economy," Porter wrote in a note to clients.

"While we had been expecting the bank to now move to the sidelines for a spell, it appears that it will take a deeper slowdown in domestic spending (as we suspect) than what we have seen so far to prompt them to stop raising rates."

In July, the bank downgraded its previous call for a 3.8 per cent advance in the second quarter - the April-June period - to three per cent.

But in fact, both were wildly off. Statistics Canada reported last week the period only produced a two per cent increase in output, about one-third the pace of growth seen in the first three months of the year.

The bank conceded that the growth profile for the economy going forward will be "slightly more gradual" than it had thought and that since proceeding to withdraw monetary stimulus in April "financial conditions in Canada have tightened modestly."

Even so, with a one per cent policy rate the cost of borrowing in Canada remains "exceptionally stimulative," the bank said.

It blamed weakness in the U.S. economy, which is being held back by the high levels of unemployment, for the slowdown in Canada. Canada's recovery has outpaced most, if not all, of the G7 leading economies, particularly the U.S., which continues to shed net jobs while Canada has recouped almost all of those lost during the 2008-2009 recession.

The bank said its policy rate is consistent with reaching a two per cent inflation target in the medium term.

But economists question how much further Carney can go with the U.S., Canada's largest trading partner, contemplating more stimulus.

Uncertainty Surrounds Rate Announcement

Uncertainty surrounds rate announcement; markets try to counter September effect

05/09/2010 6:00:00 AM

Malcolm Morrison, The Canadian Press
TORONTO - The Canadian dollar could be in for some volatility this coming week as the Bank of Canada comes out with its latest announcement on interest rates Wednesday.


The dollar ended last week at the 96-cent mark and currency markets aren't really sure which way the central bank will lean. That's because analysts were putting the odds of another quarter-point hike - to one per cent - at 50-50, reflecting a slowdown in the Canadian and particularly the U.S. economies over the last quarter.

"We are officially calling for the Bank of Canada to raise rates by a quarter point next week," said Doug Porter, deputy chief economist at BMO Capital Markets.








"But I would say an informal poll of the economics department here would probably put the odds of that at about 55 to 60 per cent. We do see it as a very close call and that's the way the market is pricing for a rate hike right now."

Meanwhile, stock markets could find momentum going into trading this week as readings last week on U.S. manufacturing and employment data could counter seasonal effects which have given September the reputation of the worst trading month of the year.

The Bank of Canada has raised rates from an historic low of 0.25 per cent twice this year, in June and July, as the Canadian economy mended from recession faster than just about any other country.

But even with another quarter-point rise, the central bank could well decide to take a pause after recent data showed North American economies slowing.

The U.S. economy grew at an annualized rate of only 1.6 per cent during the second quarter.

And Statistics Canada reported last week that the domestic economy grew at annualized reading of two per cent during the second quarter, down sharply from 5.8 per cent in the January-March period.

Back in April, when things looked rosier for the global economy, Porter thought "the bank would raise its rates to about two and a half to three per cent over the next year. Now we're thinking one to maybe 1.5 per cent."

And even before the central bank gets to that point, the question is how long it will keep rates at one per cent.

"We now see that possibly right through the middle of next year and that's really the big change in recent months for us - beyond just taking a little bit of a trip to the sidelines later this year, we think that could last longer," Porter said.

"Because frankly it doesn't look like the U.S. Federal Reserve is going to raise rates for at least the next year, and could drag well into 2012 even, unless we really get a very pleasant surprise from the U.S. economy."

However, the revised forecast is certainly good news for consumer borrowing costs and could breathe new life into a flagging housing market.

"We have seen the longer-term mortgage rates coming down in recent months as that expectation of a less aggressive Bank of Canada has been built into the market," Porter noted.

But no matter what the bank announces on Wednesday, Porter thinks there will be an effect on the loonie, particularly from the bank's commentary.

"Let's say they hike, and they come out and signal they might move to the sidelines, then the rally on the dollar won't last long," he said.

"If they hike and they still sound like they could hike further, then the currency will strengthen quite a bit. That's not even getting into what it would do if they don't hike."

Meanwhile, stock markets ended the week on a strong note as positive manufacturing data from China and the U.S. and the U.S. employment report for August, which showed private-sector job creation exceeding expectations, left the TSX at a three-and-a-half month high.

The biggest headwind might just be the fact that it is September - the worst trading month of the year.

There are a few theories why this is so. For example, mutual fund managers take profits on winning stocks and ditch the losers as they make the third quarter look as good as possible.

Last year was a happy exception, as markets were in the course of a long positive run from the depths of March 2009 as investors started to price in a strong economic rebound.

The S&P 500 has shed at least five per cent in September four times in the past decade alone.

However, this September could also prove to be a decent month.

"And that could be based on valuation that we're seeing in the marketplace, it could be based on the fact that investors will be focusing on the positives as opposed to the negatives," said Philip Petursson, director of institutional equities at MFC Global Investment Management.

"You have to focus on the fact that companies seem to be tripping over themselves to acquire each other. They are more confident and, from what we are seeing, there is much better investment opportunity in equities now than there has been over the past couple of years based on valuation, companies' balance sheets (and) pending activity through merger and acquisition activity."

Petursson added that another reason to be more optimistic on the equity markets is that, relative to bonds, stocks are cheaper than they have ever been.

Bank of Canada

Bank Prime Lending Rate
June 2, 2010 2.50 %
July 21, 2010 2.75 %
September 9, 2010 Next meeting date
Source: Bank of Canada



Bank of Canada Interest Rate
June 1, 2010 0.50 %
July 20, 2010 0.75 %
September 8, 2010 Next meeting date
Source: Bank of Canada


Conventional Mortgage - 5 Year Rate*
August 16, 2010 5.59 %
August 23, 2010 5.49 %
August 30, 2010 5.39 %
Source: Bank of Canada
*Determinant for high ratio mortgage variable qualifying rate

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Housing Prices News Article

Housing prices in hottest Canadian markets a concern
Norma Greenaway, Postmedia News • Tuesday, Aug. 31, 2010
OTTAWA -- Steep housing price increases in six of Canada’s hottest real estate markets since 2002 have all the hallmarks of an “accident waiting to happen” if mortgage rates rise too sharply, warns a new report.
The report by the Centre for Policy Alternatives says smart mortgage rate setting is needed to prevent the bubbles hanging over the housing markets in Vancouver, Edmonton, Calgary, Toronto, Ottawa and Montreal from bursting.
“The hottest six real-estate markets could be in for a correction at best or, at worst, a bubble burst,” writes David Macdonald, author of the report. “Rate setters at the big banks are in the driver’s seat now as mortgage rates inch up. They need to hit the breaks lightly.”
The chief concern is the price increases in those markets are outside the “historic comfort level,” which makes them much more susceptible to mortgage rate changes, the report said.
The average, inflation-adjusted house price in the cities has historically held stable at between $150,000 and $220,00 in today’s dollars. But the current average price in all six major markets now is over $300,000, it said.
Macdonald says a housing bubble burst has been a rare phenomenon in Canada. Since 1980, it has only happened three times — in Vancouver in 1981 and 1994 and in Toronto in 1989.
“But the steep rise in house prices in so many cities displays all the hallmarks of an accident waiting to happen,” Macdonald writes, adding the price increases have exceeded the growth in inflation, household incomes and economic growth.
“Canada is experiencing for the first time in the last 30 years, a synchronized housing bubble across the six largest residential real-estate markets in Canada.”
The report traces the trend in large part to low mortgage rates and access to easy credit, which can encourage buyers to purchase homes they might not otherwise be able to afford.
“While housing may be ‘affordable’ based on record low rates, the affordability situation in Canada could change rapidly if mortgage rates return even part way to their historic norms,” the report says.
Macdonald, a research associate with the centre, said in an interview he doesn’t expect mortgage rates to increase much in the near term. His concern is three to five years down the road.
Macdonald called on the big banks and other mortgage lenders to stick to slow, gentle increases to avert the bottom falling out of housing prices.
He also recommended returning to pre-2006 mortgage rules, which required a down payment of 10% and a 25-year mortgage. The current rules call for five per cent down and a 35-year mortgage.
Macdonald says the best scenario would be to have housing prices stagnate over the next five to 10 years while inflation slowly eats away at their value.
The goal should be to get prices back to the “comfort zone” where house prices are in line with inflation, he said, and where owners will neither gain nor lose a lot of money when they sell.
Read more: http://www.financialpost.com/news/Housing+prices+hottest+Canadian+markets+concern/3463776/story.html#ixzz0yBPfRm5D

Variable Rate Article

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/personal-finance/Variable+rate+longer/3329442/story.html#ixzz0yBQrPwKB