Lately, in the news there has been considerable discussion about rising interest rates, our economy, inflation and references to the Bank of Canada and their role in increasing rates. How it all fits together can be confusing. The short answer is, rates go up and down as our economy heats and cools. If you want more detail, read on!
First, it is important to understand what the Bank of Canada is and is not. It is NOT a “retail” bank like RBC or TD for example, which are in the business of lending money and providing banking services to businesses and consumers like you and me. The Bank of Canada (BoC), on the other hand, is a Government of Canada institution tasked to promote and protect Canada’s economic system and financial health. Among many roles, the BoC is responsible to manage inflation which they can influence by adjusting their “overnight lending rate,” which is the wholesale interest rate charged by the Federal Government and the retail banks as they lend money back and forth to one another (yes, the BoC is the bank for the retail banks!). Lower interest rates generally stimulate economic activity, by making it cheaper for firms and consumers (you and me) to borrow and spend. Higher interest rates usually have a cooling effect on growth, helping to keep inflation in check by encouraging savings instead. So when the BoC increased the overnight lending rate to 0.75% on July 12th, 2017, then again to 1.0% on September 7th, Canada’s retail banks quickly followed increasing their ‘bank prime rates,’ most recently to 3.2%. Bank prime rates are the basis for loans like variable-rate mortgages, and lines of credit.
Fixed-rate mortgages have also gone up recently, but they are not actually set by the Bank of Canada. Rather, they are determined by the auction of Government of Canada bonds, which are bought and sold by international and local investors. A bond is an investment that pays interest to the bond holder. If an investor buys a Gov’t of Canada bond, they – in essence – give money to the Canadian Government who uses it to fund programs and pays interest to the investor in return. Bond investors are constantly looking for best returns relative to risk. As price inflation increases in our economy, so does risk (risk that a dollar tomorrow will not buy as much as a dollar today), so the investors demand higher returns for their money to compensate for inflation risk. The going bond rates set at auction represent the retail banks’ cost of funds for mortgage lending for various time frames, so as bond rates increase (in response to inflation risk), so do fixed mortgage rates. Typically, one finds mortgage rates at about 1.8% above the corresponding bond rate for the same term.
Tying this all back to the Bank of Canada, their job is to control inflation, which they can influence by adjusting their overnight lending rate. If inflation risk subsides, so will bond rates, followed by stable fixed mortgage rates. If inflation is increasing, expect mortgage rates to increase as well (as should wages and job prospects). In a nutshell, it is all connected and relative. Generally, you can get a 120-day mortgage rate lock if you have a renewal coming up and you are concerned about rising rates. Concerned about the direction of interest rates and what to do? Please contact us.