National Bank’s Take on Interest Rates and Inflation
Rates
Inflation
BoC
Rates, Inflation, BoC, Oh My!
In my last blog entry we discussed how accurate economic forecast are. No one has a crystal ball, but specialists do their best to work with the information they have. Those insights definitely help us understand what we can potentially expect in the days/weeks/months/years to come.
Posted below is a correspondence I received from National Bank discussing the recent interest rate hikes, the potential upcoming Jan 26th rate raise and insights into the Bank of Canada’s thinking. It’s an interesting read:
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A lot of the recent talk in financial and real estate circles has been centering on the possibility of a pause in the Bank of Canada’s aggressive interest rate increases. Some speculate that could happen at the next rate setting, later this month.
The Bank raised rates seven times last year in an effort to rein-in galloping inflation. It does seem to be working, but there are some stubborn sticking points.
Headline inflation, known as the Consumer Price Index (CPI), has dropped. It was 8.1% in July and drifted down to 6.8% in November. However, the drop from October to November was a mere one-tenth of one percentage point and the Bank’s target rate remains significantly below that, at 2.0%.
As well, the BoC’s preferred inflation measure, Core Inflation (which strips out volatile components like food and fuel), actually increased. A simple averaging of the three components that the Bank uses to measure Core Inflation came in at nearly 5.7% in November, up from 5.3% in October.
Other factors that figure into the Bank’s plans include Gross Domestic Product and unemployment. Canada’s GDP continues to grow, albeit modestly, despite rising interest rates. It increased by 0.1%, month-over-month in November. Unemployment dipped 0.1% to 5.0% in December. Both of these tend to fuel higher wages which are a key driver of inflation.
The Bank of Canada, itself, remains firmly dedicated to battling back inflation. Governor Tiff Macklem has said he would rather over-tighten than under-tighten and run the risk of having high inflation linger and become entrenched.
The U.S. central bank has made it clear it plans more rate hikes. Given the integration of the Canadian and American economies, the Bank of Canada does have to pay attention to what its American counterpart does.
The BoC will have new economic data by the time it makes its January 25th announcement. The December numbers will provide a fresh look at how well the inflation fight is going.
Normally it takes 18 to 24 months for interest rate increases to work their way into the economy and we are only about 10 months into this tightening cycle. It is reasonable to expect another 25 basis-point increase on the 25th. Given the Bank’s apparent success so far it also seems reasonable to expect a pause sometime after that.
Looking ahead to a year from now some forecasters say we might start to hear talk of interest rate cuts, which would be welcome news. Cuts would allow the BoC to move toward its, long stated, goal of normalizing rates back into the neutral range of 2.5% to 3.5%. The Bank of Canada, and central banks around the world, have been trying to do that for more than a decade – since the ’08 - ’09 financial collapse.
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Though it’s not the best news that there’s an additional 25 basis point increase coming, it is nice to hear that there could be a “cool off” cycle to follow. If interest rates could normalize around 2.5% - 3.5% that would be great. Although, it will likely take a little while for rates to drop back down to those levels.
This does bring up an interesting question: Should a buyer get a variable rate and eat the higher interest until the rates “cool-off”, or should they get a lower fixed rate and pay the interest penalty when the rates drop low enough for switching to make sense?
Well, anecdotally, I’ve seen my clients get 4.79% fixed interest rates and TD’s Variable is posted at 6.2%, while HSBC is just under 6%. So if we use 4.79% vs 6% on a $400k, 25 year mortgage, the monthly payments would be $2,278.83 vs $2,559.23. A difference of $280.4 per month.
If your fixed mortgage penalty is not based off of an IRD (interest rate differential) calculation, but rather a simple 3 months of interest. At worst the 4.79% mortgage penalty would be approximately $4,736.10. That would mean, if the rates stayed the same, it would take 17 months for the 4.79% mortgage to save the difference for the penalty (about a year and a half).
It’s hard to say; Rates could continue to rise, they could hold around where they are for a while, or they could quickly drop down. I personally think the risks outweigh the benefits for a variable mortgage right now. However, I also think a buyer should be aware of the different types of mortgage penalties and how they work. Buyers need to make sure they’re making the best decisions for their future. Getting multiple opinions and the reasoning behind those varying opinions is crucial to understanding which options are best.
