Citing the coronavirus, rail blockades, a teachers’ strike in Ontario and even lousy winter weather in some parts of the country, The Bank of Canada (The Bank) lowered its overnight target rate by 50 basis points to 1.25 percent on March 3.
It’s the first reduction since 2015 and the first 50 basis points shave since, ironically, March 3, 2009, during the financial crisis.
In its statement, The Bank said, “While Canada’s economy has been operating close to potential with inflation on target, the COVID-19 virus is a material negative shock to the Canadian and global outlooks, and monetary and fiscal authorities are responding. It is becoming clear that the first quarter of 2020 will be weaker than the Bank had expected. The drop in Canada’s terms of trade, if sustained, will weigh on income growth. Meanwhile, business investment does not appear to be recovering as was expected following positive trade policy developments.”
It’s a significant move, says Phil Soper, president and CEO of Royal LePage.
“Certainly the most significant one we’ve seen in half a decade,” says Soper. “I believe the Bank of Canada’s statement put it in context; they are looking at all these things as a drag on the economy. It’s a very important decision and it’s rather focused — it’s not that many outside issues are at play here. Money got cheaper because things got tougher.”
It will affect the cost of mortgages, but not likely a 50 basis points reduction, says Soper.
“There are many things that go into the pricing of mortgages, which are a product just like an iPhone,” he says. “Part of their cost, the interest rate, is the cost of the money that goes into them, but the other costs involve the competition, what the other banks are doing and supply. If there’s a huge run-up in the number of people buying mortgages, it’s more likely that they won’t be lowering prices. If things are tighter, they can lower rates to try and stimulate demand, so there’s a number of things that go into the interest rate or the price of a mortgage. However, a 50 basis point change in the target rate will translate into a material drop in the cost of money and that will encourage new buyers to enter into the market, there’s no doubt about that.”
The ‘market’ Soper speaks about is the Greater Toronto Area (GTA). The revised stress test taking effect on April 6 is expected to add heat to an already red-hot GTA.
“Add to that an interest rate cut and you could have some uncomfortably high price inflation in our largest market,” he says. “The Toronto market is picking up too rapidly for housing supply to keep pace.”
Rates that will be affected by the The Bank’s cut will be adjustable rate mortgages (ARMs), says Mark Herman of Mortgage Alliance in Calgary.
“ARMs payments go down with prime,” says Herman. “Variable-rate mortgages typically do not change the payment, as it messes with remaining amortization, especially when prime goes up, but payments don’t. An important point is, as variable clients’ payments may stay the same with the change, more of the payment goes towards the principle component of the mortgage.”
Depending on what the banks do with benchmark rates, the stress test qualifying rate could be affected.
“The stress test will only be affected if there are lower rates in April when the new benchmark comes in, which will be the median rate of the actual rates sent to CMHC five-year fixed mortgages,” says Herman. “A rate drop coupled with bonds continuing to drop would result in an increase of buying and help buyers who are close to their maximum purchase amounts.
“Banks may not give the full drop to clients, though. We think the banks will be slow to lower the fixed rates because credit spreads are widening.”
“Consumers who currently have a variable rate will see their mortgage payments drop once Canadian mortgage lenders adjust their prime rates,” says James Laird, co-founder of Ratehub.ca and president of CanWise Financial mortgage brokerage. “The expectation is that prime rates will drop by the full 50 basis points, although there have been times when lenders have not passed along the full savings to their customers.
“The Bank’s stance will cause bond yields to continue to decrease, which means Canadians shopping for a fixed-rate mortgage can expect rates to fall and will likely approach the record lows of 2016. Anyone shopping for a home should check rates frequently as they will continue to decrease through the spring.”
Ever handy with a calculator, Laird does the math.
“A homeowner who put a 10 percent downpayment on a $500,000 home, with a five-year variable rate of 2.60 percent, amortized over 25 years, has a monthly mortgage payment of $2,102,” says Laird. “With the 50-basis point rate decrease, their mortgage rate has decreased to 2.10 percent and their monthly payment has decreased to $1,987, meaning this homeowner will save $115 per month or $1,380 per year on their mortgage payments, compared to what they were paying before.”
The Bank’s next rate announcement is April 15, and it added fuel to the up-or-down speculation fire with this closing statement: “As the situation evolves, Governing Council stands ready to adjust monetary policy further if required to support economic growth and keep inflation on target.”
“This suggests additional rate cuts may follow this year,” says Laird.
All logic aside, if The Bank reduced the rate because of lousy winter weather, we’d have cuts every month from September to April.
Copyright Postmedia Network Inc., 2020
