How interest rates are working against both borrowers and savers

We're in a strange position today where interest rates are working against both borrowers and savers.

Mortgage rates are rising, but there's no corresponding benefit to savers and conservative investors. The explanation for this frustrating turn of events begins with the rise in the interest rate on government bonds in the past eight weeks or so. A five-year bond issued by the federal government now yields about 1.84 per cent, compared with 1.15 per cent on May 1. As measured in T-shirt sizes, that move is a definite XXL.

Lenders use bond yields as a benchmark for setting their mortgage rates, which explains why five-year mortgage rates are more expensive than they were in the spring. As for investors and savers, it's true that someone buying a five-year Government of Canada bond can get a substantially higher return than they would have received a couple of months back. But people who use guaranteed investment certificates have seen virtually no change in rates, and the same goes for high-interest savings accounts. In fact, financial industry consultant David McVay says savings account returns today are leaner than they were last fall.

The problem for savers and conservative investors is that banks, trust companies and credit unions set rates not only in response to financial market conditions, but also to their level of profitability. Mr. McVay said growth in the banking business is slowing, and that's putting pressure on profits.

As a result, banks are trying to widen the spread between the rates they use for lending and those for savings. "I expect that what you're going to see is mortgage rates going up fairly reliably with the bond market, while GIC and savings rates will go up at a slower pace," Mr. McVay said.

Last month, it was no big deal to get a five-year fixed rate mortgage in the area of 2.89 to 2.99 per cent. If you check mortgage brokerage websites today, you'll typically see a rate of 3.09 to 3.19 per cent shown. At least one big bank's discounted five-year rate has risen by 0.4 of a percentage point to 3.49 per cent.

Meanwhile, the Bank of Canada's online interest rate database shows no change in the average five-year GIC rate since early May. Expect to find yields of 2.7 per cent at best from credit unions and alternative banks and less than 2 per cent at major banks.

High-rate savings accounts take their cue mainly from the major banks' prime rate, which in turn is influenced by the Bank of Canada's overnight rate. Neither rate is expected to move any time soon. Still, with Canadians' hunger for higher rates stoked by what's happening in the bond market, it's reasonable to wonder if there's a bank out there that might try to get the jump on its competitors with a higher savings rate.

Mr. McVay said the trend for high-rate savings is actually down. In his most recent note to clients, he said several banks and credit unions recently matched Toronto-Dominion Bank's move last November to trim its high-rate savings account return by 0.1 of a percentage point to 1.1 per cent.

Competitiveness in the high-rate savings market has been on the decline since Royal Bank of Canada swallowed Ally Canada, which had for several years been a reliable leader on rates. Mr. McVay expects banks to raise rates on these accounts at a slower pace than any increases in the prime rate. "I would say that for every three-quarters of a point in the prime you'll see half a point in high-rate savings accounts. They'll move, but slower."

While the Bank of Canada's overnight rate is on hold for now, it's widely expected to rise at some point next year. Mr. McVay said when this happens, the banks will be in the unhappy position of having to pay more interest on the billions they've collected in high-rate savings accounts. To reduce this risk, he expects the banks to encourage customers to move into GICs, where the return is locked in and there are no open-ended worries about having to pay more.

Don't let the banks herd you like a sheep. If you're going to move from a high-rate savings account to a one-year GIC, make sure you get a decent interest rate premium to offset the fact that you're losing day to day access to your money.

Wednesday at noon (ET), join Rob Carrick in a live discussion about financial advice for young Canadians (tgam.ca/DsE8). Send your questions to rcarrick@globeandmail.com--------------

High-rate savings accounts

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Wednesday June 26 at noon (ET), join Rob Carrick in a live online discussion about financial advice for young Canadians. Send your questions to rcarrick@globeandmail.com.