Episode # 25 of the Mortgage Foundations Podcast
As expected by many, the Bank Of Canada announced this morning that it was cutting the policy interest rate by 25 basis points from 5% to 4.75%. Most lenders are expected to follow suit and cut their prime rate by an equal amount, meaning most will now be at 6.95%.
This was the first time in 4 years that the Bank Of Canada has cut the rate and more importantly, may have marked the end of their rate hike cycle that began in 2022. 'May' is the important word here as nothing is guaranteed and if it is shown that the Bank Of Canada has cut the rate too soon, we could potentially see them back pedal and have to raise the rates to fix the issue.
Today's rate cut announcement was definitely welcome to many people, none more so than those that are currently in an Adjustable Rate Mortgage, which is a variable mortgage where a client's payment fluctuates with changes to their lender's prime rate. When the prime rate increases, so does the payment, and vice versa, when the prime rate decreases, the payment does as well. This is different from a static payment variable rate mortgage, where instead of the payment changing, the ratio of the amount of the payment that goes to principal and interest changes instead.
To put the change into a dollar amount, for every $100,000 of mortgage balance owing, a quarter point change in prime rate equates to a difference of 15 dollars up or down. Therefore, for someone with a $500,000 mortgage balance, today's announcement would mean that their future monthly payments will be reduced by 75 dollars. Admittedly, this is not a huge sum of money and covers a small grocery bill; however, for families that have been struggling with rate increases over the past couple of years, any amount of relief is welcome I am sure.
It is important to note that this morning's announcement does not affect fixed mortgage rates, as fixed rates are affected by the bond market and bond yields. Depending on how the market reacts to the Bank Of Canada's rate cut and the comments made afterwards; we may see fixed rates adjust at some point, but, not in lock step with prime.
As referenced earlier, the Bank Of Canada does need to be careful with further rate cuts and needs to take the financial situation in the US into account before making these cuts. Even though it is true that both countries central banks operate independently from each other, having too large of a gap between each other's policy rate could prove to increase the problem that the Bank Of Canada has been working to fix. Specifically, inflation.
Without getting too deep into the economic reasons why this could happen, I will summarize the key points. A lower policy rate can lead to a weaker dollar since foreign investment may be reduced as lower interest rates are obviously not as attractive to investors. Less demand for the Canadian Dollar means that it may fall in value against other currencies, mainly the US Dollar. If the Canadian Dollar falls too much, we could see the cost of goods increase, and if they increase too much, we could start to see inflation creep back up. This would not only include goods that we import into Canada; it would also include domestic goods that are dependent on imported raw materials.
The other concern that the bank will be paying attention to is whether today's rate cut causes consumers to react and increase spending, including on real estate. While a quarter point cut to the prime rate is not likely to cause many potential home buyers to come off the sidelines, bond markets reacting and causing fixed rates to decrease could. Many potential home-buyers (especially first timers) are more likely to take a fixed rate; therefore, until fixed comes down, qualifying isn't really affected much.
Today's rate cut is definitely a good thing and welcome relief for many Canadians; however, I believe that it may have been a one and done cut for now, and then wait a bit for the next one to gauge the effects. With that being said, I was expecting that the Bank Of Canada would wait till their July meeting for the first cut; I would be happy to be wrong again.
