BoC overnight rate influences mortgage—analyst

The Bank of Canada’s most recent announcement maintained the target rate at 0.5 per cent, justifying it on grounds of the global economy seeing gradual recovery in the past few months.
“Financial market volatility, reflecting heightened concerns about economic momentum, appears to be abating. Although downside risks remain, the Bank still expects global growth to strengthen this year and next,” the BoC stated during the announcement.
The full effects of the flat overnight rate on the Canadian economy remain to be seen, but in an analysis piece published on its website, MoneySense senior editor and licensed realtor Romana King broke down the possible impact of the development on mortgage rates.
King noted that for the most parts, banks will adjust their prime lending rates on variable mortgages in accordance with any changes to the overnight rate.
“The theory is that Canadians will spend less if it costs more to borrow and this reduces spending and, ultimately, inflation,” King wrote.  “If, however, the BoC. wants to increase inflation it will drop its overnight rates. This allows banks, lenders and credit unions to lower their mortgage rates, personal loan rates and credit card rates, which should stimulate more borrowing from Canadians. The logic is that Canadians will spend more when it’s cheaper to borrow money; this increases demand and, subsequently, boosts inflation.”
On the other hand, King said that fixed-rate mortgage products are contingent on the pricing in the bond market.
“In simple terms, banks make the money they use to loan [consumers] a mortgage from the spread between what they lend and what they borrow. This spread is, in part, dictated by bond rates. So banks look at the yield, or interest rate of bonds to set fixed mortgage rates,” King stated.
The analyst said the gradual upward trend in mortgage rates across the board should be attributed to recent regulatory changes that have reduced housing risk by compelling banks to assume a greater portion of mortgage loan risk—which in turn has forced lending institutions to pass on the added cost to borrowers.
“Keep in mind, though, that we are still in atypical times. Normally in such a turbulent economy, with oil hovering at $30 US a barrel and the loonie sitting tight at 75 cents US, mortgage borrowers should expect a drop in mortgage costs, especially fixed rates,” King concluded.

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