The Bank of Canada has slashed its key rate for the third time this month, using what many think are its last rounds of monetary policy ammunition.
- Rate Announcement: 50-bps emergency cut
- Overnight rate: Now 0.25%
- Prime Rate: Currently 2.95%; pending change to potentially 2.45% (see Prime Rate)
- Market Rate Forecast: No further change in 2020
- BoC’s Headline Quote: “This unscheduled rate decision brings the policy rate to its effective lower bound…”
- BoC on the Economy: “The spread of COVID-19 is having serious consequences for Canadians and for the economy, as is the abrupt decline in world oil prices.”
- BoC’s Full Statement: Click here
- Next Rate Meeting: April 15, 2020
The Spy’s Take
The bond market is now pricing in a possibility of another rate cut this year. It’s anyone’s guess if that happens, but if it does it could take Canada’s key interest rate down to 0%, a never-before-seen level.
The Bank also announced today that it will buy government bonds until “the economic recovery is well underway.” That could eventually push fixed mortgage rates lower given their link to the bond market. (Added bond buying pushes up bond prices and pushes down bond yields.)
Poloz on Negative Rates
“Interest rates below zero are in the monetary policy tooltkit,” Poloz confirmed. He added that negative 50 bps (-0.50%) is the widely accepted theoretical lower bound.
But Poloz was clear that the “negative effects for the financial system are pretty significant” with sub-zero rates. Moreover, monetary policy is having very little effect with the economy shut down. So, at this stage it would be “not sensible” to consider a move to negative rates, he said, adding, it’s “not one we’re contemplating” at this time.
The BoC said rates will stay this low until the economic recovery is “well underway.” No one knows how long that is but it generally takes at least a year and a half for unemployment to top out during severe recessions.
With Alberta oil now cheaper than a Starbucks latte (it’s now trading at a record-low $5.03), and with short-term unemployment becoming long-term unemployment for some, this won’t be a quick “V-shaped” recovery.
Floating Rate Cuts
The mortgage market is now waiting to see if banks pass through the full cut to prime rate. The expectation is that they will, given public statements from the BoC and Finance Department about how important that is for the economy.
Those in an adjustable-rate borrowers will see their payments fall roughly $24 a month for every $100,000 of mortgage balance. Variable-rate borrowers with fixed payments will see more of their payments go to principal each month.
Prospective variable-rate shoppers may not enjoy the full benefit of today’s cut, however. That’s because banks may choose to cut floating-rate discounts.
Existing floaters with big fat discounts will fare best. On March 10 we suggested variable rates for most well-qualified risk-tolerant borrowers. At that time, you could still fetch variable discounts as hot as prime – 1.32%. But that window was short. Now, if you can find prime – 0.30%, you’re lucky.
Fixed Rate Outlook
Five-year swap rates, a rough proxy for a bank’s basic 5-year fixed funding costs, plunged 25 bps after today’s BoC’s move. Normally that would be positive for fixed mortgage rates. Unfortunately, credit spreads are surging, with banks’ 5-year funding costs climbing in the bond market by a similar amount.
We’ll need to see a reduction in the risk/liquidity premiums that investors are demanding from banks before fixed rates come down materially. That could take weeks or many months. It’s impossible to say.