January 9, 2019

Bank of Canada Holds January Rate as Low Oil Prices Persist

Lingering pain in the oil sector continues to derail the Bank of Canada’s plans, with lower-than-expected prices hampering economic growth and weakening the central bank’s mandate to increase rates. As a result, it has held its trend-setting interest rate at 1.75% in this month’s announcement.

“Global benchmark prices for oil have been about 25 per cent lower than assumed in the October Monetary Policy Report (MPR). The lower prices primarily reflect sustained increases in US oil supply and, more recently, increased worries about global demand. These worries among market participants have also been reflected in bond and equity markets,” stated the BoC in its release.

It adds that the drop in energy prices has had a “material impact” on Canada’s economic outlook, with consequences for trade and national income, and investment in the oil sector to weaken further. Growing tensions around the U.S.-China trade conflict, and its impact on the global economy, are also a factor, with global economic growth to soften to 3.4% this year from 3.7% last.

Slower Housing Market Hitting Economy

Overall household investment and spending is down across Canada, spurred by challenges facing the housing market which continues to absorb the impact from new provincial and federal policies, tougher mortgage rules, and higher interest rates. Demand for houses for sale and spending will continue to worsen in provinces hardest hit by lower oil prices, the BoC adds, leading to a chop in its national growth forecast for the year; GDP will increase by 1.7% this year – 0.4% lower than what was forecasted in October. Core inflation also fell to 1.7% as a result of lower oil prices.

A Temporary Downturn

However, the BoC insists this doom-and-gloom prognosis will be temporary, with economic growth to pick back up to 2.1% by 2020 and inflation back on track to hit its 2% target.

“These developments are occurring in the context of a Canadian economy that has been performing well overall,” it states. “Growth has been running close to potential, employment growth has been strong and unemployment is at a 40-year low. Looking ahead, exports and non-energy investment are projected to grow solidly, supported by foreign demand, the CUSMA, the lower Canadian dollar, and federal tax measures targeted at investment.”

It also hasn’t backed down from its plan to eventually hike rates, saying a neutral range between 2.5 – 3.5% will eventually be necessary to keep inflation in check.

“Weighing all of these factors, Governing Council continues to judge that the policy interest rate will need to rise over time into a neutral range to achieve the inflation target. The appropriate pace of rate increases will depend on how the outlook evolves, with a particular focus on developments in oil markets, the Canadian housing market, and global trade policy,” it states.

This is in direct contrast to some economists’ expectations that a rate cut could be in store this year, rather than the upward trajectory the BoC has touted throughout 2018; it has increased its interest rate, which is used by Canada’s consumer lenders to set their cost of Prime borrowing, five times since July 2017. According to the most optimistic analysis, there may be room for one or two more this year – though unlikely should the oil sector not turn around.

What Does This Mean for Your Mortgage Rate?

You can breathe easy if you have a mortgage or line of credit with a variable rate – because the BoC’s Overnight Lending Rate is used by your bank to set your interest rate, your monthly payment, or the amount of your payment going toward your principal debt, won’t change in the near term.

That the BoC has hit pause on its hiking mandate may also translate into lower rates for fixed-mortgage borrowers as well. While the fixed cost of borrowing isn’t directly impacted by the BoC’s monetary policy, it is influenced by the bond market, which is very sensitive to interest rate movement. Bond investors are happy when the BoC cuts or holds its rate, as it means the yield on their investment – its payout upon maturity – remains competitive in comparison to newly-issued bonds.

On the flipside, when the BoC hikes rates, the yields on new bonds rises, devaluing those already in existence. As lenders take their cue from this market, and tend to pass savings onto customers when yields are low, this could translate into lower fixed rates for new borrowers, or those coming up to renewal.