Bank of Canada playing follow the leader on rates

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[The Canadian economy is heavily dependent on housing, record household borrowing and consumption to support 90 per cent of GDP growth. Will Canada line up like a good little duck behind the US in raising rates, or will it pay attention to our actual economy? Watch the video in this story to hear some cogent reasons why we should not be raising interest rates at this time: 'Misguided' for Bank of Canada to raise rates: Capital Economics. See also: Canadian Mortgage Borrowers Face 'Perfect Storm' Of Rising Rates, Even Tougher Rules. *RON*]

Martin Pelletier, Financial Post, 10 July 2017

Stephen Poloz, Governor of the Bank of Canada, is expected to announce the bank's rate call on July 12.THE CANADIAN PRESS/Sean Kilpatrick
Strange things are afoot with central banks these days as many are following the U.S. Federal Reserve’s lead and looking to tighten monetary conditions by raising interest rates. While we like to think that we chart our own course, Canada is no different in playing follow-the-leader as evident by the historical correlation in interest rate movements between our two countries and the recent indications by the Bank of Canada and its governor Stephen Poloz.

In particular, Canadian bond yields are now implying a 91.4 per cent probability that the Bank of Canada will raise interest rates this week, according to recent analysis by the Financial Times. This is up from the 4.6 per cent recorded just over 30 days ago.

What is interesting is that there has been no change in the Bank’s outlook since its last two meetings and the economic data — other than the recent jobs report — has either been in-line with or slightly below the Bank’s expectations.

While a 25 basis points hike may not sound like much, it has certainly had a meaningful impact to the Canadian dollar and bond market over the past month. Government of Canada Marketable Bonds with terms from one to five years have seen their yields increase 75 per cent since the beginning of June.

The loonie has now delinked from its historical relationship to oil prices and has gained an impressive 7 per cent against the U.S. dollar since May and could soon surpass the US$0.80 mark. While a higher loonie is great for those of us who vacation south of the border, it will not be good for our energy producers, who sell oil in U.S. dollars, and our overall balance of trade on a national level.

The debt-heavy consumers who are driving our economic growth also don’t appear ready or able to take on higher interest rates. A recent survey by MNP Ltd. indicated that 27 per cent of Canadians who have a mortgage agree that they are in over their head with their current mortgage payments. The same survey also showed that 77 per cent of Canadians would have difficulty absorbing an additional $130 per month in interest payments on debt. That’s the cost of a Starbucks Caramel Frappuccino per day.


They will soon be tested though as a number of Canada’s big banks have already begun increasing their mortgage rates from 5 to 20 basis points in anticipation of a Bank of Canada rate hike.

The problem is that our economy has become real-estate focused and it is unclear just how much of an effect higher interest rates will have on GDP growth. For example, according to Stats Canada and Macquarie Research, just the transaction fees alone associated with buying and selling a home now account for a record 2 per cent of GDP. Talk about a great time to be a realtor!

What worries us is that Toronto home sales appear to have peaked and are rolling over, with the number of transactions falling by more than 37 per cent from last June and by more than 50 per cent in the past three months. This is important as nearly half of all the high-ratio mortgages (loan-to-income ratios in excess of 450 per cent) in Canada originated in Toronto.

As a result of a slowing housing market, weak energy prices, and a rising loonie it wouldn’t surprise us to see a material impact to our country’s economy going forward. We’re not alone as Capital Economics is forecasting moderating GDP growth to a paltry 1.2 per cent next year.

In the end, this could all be moot since our central bank tends to follow its big brother south of the border regardless of our own situation.


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