Heightened global instability, including the disaster in Japan, has granted a temporary reprieve for Canadians who need to obtain or renew home mortgages.
Royal Bank of Canada, the country's largest bank, cut mortgage rates on Tuesday in a move that marks an unexpected turning point.
It was just under a year ago that lenders finally initiated what was expected to be a relatively swift and steady increase in mortgage rates in the wake of the financial crisis. Financial instability in Europe caused the banks to change course for a time, but the upward momentum later resumed, with lenders increasing mortgage rates in early February as confidence rose in the global economic recovery.
Now, the bankers are taking their cue from bond rates, an important determinant of their funding costs, said Toronto-Dominion Bank chief economist Craig Alexander. "If they see the five-year bond yield drop and it looks like it's going to be sustained for some time, they will reduce mortgage rates," he said.
U.S. and Canadian bonds had been rallying prior to the disaster in Japan, as instability in the Middle East caused concern about higher oil prices, prompting investors to move into the relative safety of fixed-income instruments. Between March 3 and March 10 - the day before the quake - five-year Canadian bond yields dropped by 16 basis points as bond prices rose.
"Then you had the earthquake and tsunami and that has pushed [yields]down by even more," said Mr. Alexander. "Right now they are sitting at 2.52, so you've basically had a 15-basis-point drop since the earthquake hit."
After one bank reduces mortgage rates, the rest of the industry tends to follow suit. In fact, Bank of Montreal came out Tuesday evening with mortgage rate cuts, and other banks are likely to follow.
RBC cut rates on its four- and 10-year fixed-rate mortgages by 0.15 percentage points on Tuesday, while the five-year rate was cut by 0.10 points and the seven-year rate by 0.20. The bank's special rate on a five-year closed mortgage now stands at 4.19 per cent.
CIBC World Markets economist Benjamin Tal said he still believes mortgage rates are going to steadily rise in the longer term, but "any negative development such as the recent situation in Japan works to shift activity from risky assets such as stocks towards bonds, which of course is benefiting home buyers."
The same instability that's affecting mortgage rates could also provide a reprieve for other borrowers, such as those with lines of credit, if it causes the Bank of Canada to be more cautious about boosting interest rates.
"The market still has some rate hikes priced in, but it sees a much less aggressive path for the Bank of Canada later this year," said Douglas Porter, deputy chief economist at BMO Nesbitt Burns Inc.
Mr. Alexander said TD will lower its near-term interest rate projection, but he does not think the situation in Japan will have any impact on interest rates by the end of this year.
"If people were worried that rates would head steadily higher, it creates a near-term reprieve, but make no mistake that rates are going to go up," he said.
In fact, he said there is a chance that lower mortgage rates could actually prompt the Bank of Canada to raise its key interest rate sooner. That's because one of the central bank's main concerns has been the unprecedented debt levels Canadian borrowers have racked up, chiefly in mortgages. Low mortgage rates could compound that problem.
"The Bank of Canada would like to see Canadians moderate the rate at which they're taking on debt," Mr. Alexander noted. Mortgage debt that Canadians held with the chartered banks stood at $506.5-billion in December, up from $505.8-billion in November and $468.3-billion in January of 2010, according to the latest data from the Bank of Canada.