Bank of Canada Leaves Key Rate at 0.25%

After slashing rates three times in March and buying billions in bond market instruments to further suppress interest rates, the Bank of Canada pressed <Pause> today. Here’s what happened and how mortgagors should respond.

• Rate Announcement: No change
• Overnight rate: 0.25%
• Prime Rate: 2.45% (see Prime Rate)
• Market Rate Forecast: No change until at least 2022
• BoC’s Headline Quote: “The Bank’s Governing Council stands ready to adjust the scale or duration of its programs if necessary.”
• BoC on the Economy: “…The global economic recovery, when it comes, could be protracted and uneven.”
• BoC’s Full Statement: Click here
• Next Rate Meeting: June 3, 2020

The Spy’s Take

Reader Note: If you want to understand the logic behind the mortgage strategy that follows, read on. If econo-talk dulls your senses, skip to the bottom section.

Some quick points:

• Despite the Bank saying its key rate is already at its “effective lower bound,” the bond market continues to price in a roughly 1-in-3 chance of another rate cut before year-end.
• Lending markets are functioning better than three weeks ago but “remain strained,” the BoC said, despite extraordinary government support.

• Oil plunged to 21-year lows this morning on fears over demand destruction and a supply glut. That continues to threaten jobs in Canada’s oil industry and should further weigh on rates until crude prices (WTI) rebound well above $30.
• “CPI inflation is expected to be close to 0% in the second quarter…” the Bank said. That’s a sobering projection given inflation expectations are the #1 driver of mortgage rates and the fact that BoC’s minimum allowable inflation target is 1%.
• Consumers and businesses—many financially constrained, overindebted and fearful of the unknown—will continue under-spending for several quarters. As the BoC puts it, “…Uncertainty and scarring effects of the recession on confidence and production capacity could prolong the recovery substantially.”
• Persistent deflation could make it harder for Canadians to service debts, Governor Stephen Poloz said today. He suggested that outcome is unlikely, however.
• In a worst-case scenario, which the BoC deems less likely:
  • Thousands more businesses and exporters than expected could “permanently close their doors.”
  • Hundreds of thousands of workers could face “longer spells of unemployment.”
  • Together, these factors could “cause structural damage to the economy that might not be undone for several years, if ever.”
  • “…Credit markets may be impaired and slow to recover, despite central bank support.”
  • And none of this even acknowledges the unquantifiable risk of a housing crash, which economists say is unlikely, but could potentially cause a depression if it occurred.
• On a related note, StatsCan previewed Q1 GDP today, suggesting economic growth was -10.5% annualized during the quarter. Numerous economists think Q2 GDP will drop an unprecedented 25%+, making it the worst recession since the Great Depression.
• “Canada’s large lenders are well-positioned to weather a severe economic and financial downturn,” the BoC reassured.
• Once COVID-19 is largely past us, pent-up demand and lagging supply could boost inflation (and interest rates) quicker than expected.
• Interestingly, the BoC was supposed to announce its new neutral rate estimate today. Instead, it deferred it till October 2020, citing a “high degree of uncertainty” in its outlook. “Neutral” is the theoretical rate that neither stimulates nor restrains inflation. Needless to say, the Bank’s current neutral rate estimate of 2.75% seems way out of whack.

How to Play It?

• As COVID-19 treatments and vaccines eventually roll out, mortgage rates should revert somewhat higher. The key message for now is that hundreds of thousands of Canadians will never get their jobs back post-pandemic. For that reason, among others, a full economic recovery could take years, plural.
• Today’s BoC meeting therefore does not change the mortgage playbook for most well-qualified, risk-tolerant borrowers. For them, leaning towards the lowest mortgage rate they can find, regardless of term, makes sense — so long as:
  • The mortgage features and term length match one’s 5-year plan
    • i.e., portability, refinance and prepayment options all meet their needs
    • households with employment or budgetary risk, for example, may be better suited to a deep discount, full-featured portable 5-year fixed rate
  • The penalty is reasonable
    • if there’s any chance of changes to the mortgage before maturity
    • don’t ignore this point if there’s a chance you’ll need to sell your home before your mortgage matures
  • The advice and service of the mortgage provider are adequate
    • To the extent one is willing to pay more for this, and less-experienced mortgage shoppers often should
• Basic funding costs dropped today in the mortgage market (as measured by Canada’s 5-year swap rate, which reflects a bank’s base cost to fund a fixed-rate mortgage).
• Counteracting this are slightly widening credit spreads (meaning lenders must pay a bigger premium above their base costs to procure mortgage capital).
• Net-net, current market action implies flat to slightly lower fixed rates near-term, minimal short-term changes to variable rates and heavily suppressed rates (overall) through at least 2021.