Watch the U.S. Federal Reserve over the next several months to understand what's ahead for mortgage rates in Canada.
Our economy is weak and there's zero chance of the Bank of Canada raising rates any time soon. But we're not in total control of our interest-rate destiny. If rates in the United States rise in the months ahead, we may feel it in the form of slightly higher mortgage rates. You really have to push yourself to make a serious appraisal of interest rates these days. They've been in a stable-to-lower trend for the better part of eight years and thus are regarded by a lot of borrowers as a benign force in the economy. But regardless of whether the outlook for rates is up, down or sideways, there are opportunities to fine-tune your finances.
One of the challenges in sizing up rates today is the divergence between the Canadian and U.S. economies. While momentum ebbs and flows, the U.S. economy is gaining strength to the point where there's an expectation that rates will rise later in the year.
The most recent take on our own economy suggests there's nothing doing on rates. "The consensus now doesn't have the Bank of Canada hiking interest rates until 2018," said Douglas Porter, chief economist at BMO Nesbitt Burns. "Officially, we forecast one hike in the fourth quarter of next year. But that's based on the assumption that the Fed raises rates a few times in the interim."
The Bank of Canada influences borrowing costs through its overnight rate, which sets the trend for the prime rate at major banks. As goes the prime, so goes the interest rate on your line of credit, variable rate mortgage and some consumer loans. If you have any of these types of borrowing, you've got some breathing space right now. Use it to pay down what you owe and make yourself less vulnerable to the uncertainties of today's economy.
Fixed-rate mortgages are a different story. They're guided by yields on government bonds, which reflect prevailing attitudes in financial markets about where interest rates are headed. If rates seem to be heading higher, then the yields on government bonds will increase. If the outlook is for lower rates, then bond yields will start to decline.
Unfortunately, yields on Government of Canada bonds are linked to what goes on the U.S. market as well as what's happening here. This is why the Fed increasing its version of the overnight rate in the United States would affect Canadians. "If the Fed does what we think they're going to do, we think there will be a little bit of upward pressure on longer-term rates here in Canada," Mr. Porter said. That suggests higher rates on five-year mortgages.
All of this reinforces the slight near-term advantage for the variable-rate mortgage over the popular fixed five-year term. Mr. Porter believes the Bank of Canada's overnight rate will remain steady for the next 12 to 18 months. Today, these mortgages are going for roughly 2 to 2.4 per cent with discounts, compared to five-year fixed rates in the range of 2.2 to 2.5 per cent.
In the next six months, it's possible that fixed rates could drift a little higher while variable-rate mortgages hold steady. Going with a variable rate also lets you benefit if the Bank of Canada's overnight rate happens to fall in the months ahead.
Mr. Porter ranks this as a remote possibility – we'd need to see the U.S. economy stumble or another decline for oil prices. Still less likely are negative interest rates, which have been introduced in countries such as Japan, German and Switzerland to encourage economic growth. Results to date have not made a great case for this strategy, he said.
Some people worry that years of low rates will be followed by a snap-back that sends rates higher in a hurry. "I personally think the risks are more toward a prolonged period of very low inflation and low interest rates," Mr. Porter said.
That sounds like ideal conditions for borrowing, but it's not. Low inflation and low rates are a feature of an economy delivering weak growth in incomes and employment. In that kind of world, the best move on debt is to get rid of it.