The Bank of Canada on Tuesday cut borrowing costs to a record low as it warned the economy will shrink this year. In a further move to bolster the sagging economy, the bank reduced its key overnight rate by half a percentage point to one per cent. The bank has now trimmed 3.5 percentage points from the overnight rate since it started its latest cycle of cuts.Tuesday's cut reduced borrowing costs below 1.12 per cent, which had been the lowest point set back in 1958.
More rate reductions may also be in the offing, as the Bank of Canada said more stimulus could be needed to boost the sagging economy."Major advanced economies, including Canada's, are now in recession and emerging-market economies are increasingly affected," the bank said."Canadian exports are down sharply, and domestic demand is shrinking as a result of declines in real income, household wealth, and consumer and business confidence."
Bank sees recovery in 2010
The Canadian economy is expected to contract by 1.2 per cent in 2009, but the bank sees a recovery in 2010, when the economy is projected to expand by 3.8 per cent.Back in October, the bank projected growth of 0.6 per cent in 2009, and 3.4 per cent in 2010.The bank will provide more details on its outlook for the economy on Thursday, when it releases its Monetary Policy Update.
The bank also signalled that inflation fears have abated. The so-called core inflation rate is expected to fall to 1.1 per cent in the fourth quarter of this year, while the overall inflation rate is expected to dip below zero for two quarters in 2009 because of lower energy prices."With inflation expectations well-anchored, total and core inflation should return to the two per cent target in the first half of 2011 as the economy returns to potential," the bank said.
The major Canadian banks quickly moved to reduce their prime rates to three per cent. That differed from some of the past moves by the Bank Canada, when the big banks either delayed lowering their prime rates or did not pass along the full cut. The banks cited the tight credit markets as the reason why they were not passing along the cuts to customer borrowing rates.
Borrowing is getting cheaper if you can qualify and you are willing. It doesn't seem like the willing qualify these days and the qualified seem unwilling!
A worthy question is what happens to prices when mortgage rates drop and there is definitive oversupply?
Lower interest rates will raise the bottom a little bit. If it's cheaper to borrow, buyers can afford a larger purchase price. What it won't do is "restart" the RE market any time soon. Prices have much more to fall before any kind of rebound is in the cards.
The supply / demand issues at play are way larger than the effect a small cut in interest rates can have.
I often wonder how many buyers will pocket the savings of lower interest rates. With oversupply, more likely they will increase the quality/size of property they buy. If so, falling rates has close to zero impact on prices until there is significantly less oversupply.
Also, with falling rates, do you think landlords will "pocket" or "pass on" the savings to renters? In a competitive market? Wouldn't lower rates have the effect of eventually lowering rents as well?
Those are all great questions that I'm also thinking about. I've been playing around with mohican's "fair value" formula - this interest rate cut makes a *big* difference, to the tune of about $80,000 on a typical 3Br renting for $1600 a month.
The rent part of the equation is also in flux - if I can negotiate a $100 decrease in my rent (high likelihood), the equation says to keep waiting.
If I keep paying the rent I'm paying, then it says "hmm! time to start looking for a deal."
But being conservative financially, I'd like to improve my situation rather than just match the current one. Since rates are abnormally low, I have to consider 5 years from now as well.
Interesting times. The answers to the prices and rents question will soon be known. Luckily I'm in no hurry to do anything.
Yes, interest rates make a big difference to the rent vs buy calculation.
Five year mortgage rates are 4.5% right now - that is very low.
Wompeter - I hear you - when we bought, we dramatically improved our living situation and ended up paying no more than rent.
We weren't looking to buy but the fact that another baby is on the way definitely affected the decision. Essentially, we had to move anyway so we kept an open mind about buying so long as the deal was good enough and it was less than rent. Surprisingly, for us, it happened.
Jesse - rents will fall provided there is less demand for rental units than the available supply. Landlords prefer 'some' dollars to top dollar! Rents fall if there are substantially more available units than renters. I think landords would prefer to pocket the interest savings but it may not be their choice.
I think my point is that mohican's model (Rent - Expenses)/(5 year mortgage rate) has some confusing results when approaching zero bound. The mortgage rate may not always be the best gauge of how to discount cash flows for a long term investment.
You saved me atleast 100k thank you for your efforts on this post!
Glad I could be of service Brett. I'll take that 5% commission now too!
One thing about the lowered interest rates that seem problematic to me is that in Canada, it's not like in the US, where you lock in your borrowing terms for the whole mortgage. I thought in Canada it's usually five years?
So if you buy when interest rates are low, and that lets you stretch to pay a higher actual price, couldn't you be really caught when your mortgage term comes up for renewal? So that you could be stuck either paying quite a bit more, or trying to sell in an environment where people can afford less (due to the cost of borrowing).
Yes I agree a large mortgage at historically low interest rates is big risk. If you go for 5 years and then renew you're likely to have a whacking increase in your payments. Coupled with the risk of your asset depreciating and the shaky job market I think waiting is a wise thing to do.
Blogger ella said...
"So if you buy when interest rates are low, and that lets you stretch to pay a higher actual price, couldn't you be really caught when your mortgage term comes up for renewal?"
I believe that's a key issue that can prolong this housing downturn. Can interest rates stay this low for the long term??? Rates were moderate at the beginning of the 81/82 RE crash, and then skyrocketed up, which really screwed people up even more. Now I think the inflation adjusted RE prices are (still) higher than they were in the run up to 81/82. We have a larger way to fall with an increase in interest rates.
The psychology of buying when interest rates are so low seems almost as dangerous as buying RE or stocks when everybody is euphoric about them. I'd rather buy when the interest rates were high and reap the benefits when they fall. Besides, when rates are high, sellers would have to lower their prices to an affordable level in order to sell. In that sense, current interest rates should have no affect on the affordability of housing. Supply/demand and market psychology would have a far greater effect I would think.
"Can interest rates stay this low for the long term???"
I can't think of any situation in history where this occurred. Oh wait, maybe one: Japan, and their real estate prices have been falling for close 20 years, even with low rates. Just sayin'
Rates were moderate at the beginning of the 81/82 RE crash, and then skyrocketed up, which really screwed people up even more. Now I think the inflation adjusted RE prices are (still) higher than they were in the run up to 81/82.
Moderate? Rates were already very high at the top of the market in 1981, about 16%. They hit a peak of about 21.5% later that year and then declined substantially as the market continued to tank. At the real price bottom in 1985 they were down to 11%.
AVERAGE RESIDENTIAL MORTGAGE LENDING RATE - 5 YEAR
Real prices today are way higher than at the market top in 1981. Imagine what just a return to mid-80's interest rates would do.
In a added change to reenforce the sagging frugalness, the cant low its key long rate by half a pct sail to one per coin. The bank has now trimmed 3.5 percentage points from the long evaluate since it started its last pedal of cuts.Tuesday's cut low borrowing costs below 1.12 per centime, which had been the lowest direction set posterior in 1958.
Writer assess reductions may also be in the offing, as the Repository of Canada said writer stimulus could be needful to raise the sagging action."Outstanding modern economies, including Canada's, are now in cession and emerging-market economies are progressively touched," the array said."River exports are plumage sharply, and domesticated duty is decrease as a termination of declines in genuine income, menage wealthiness, and consumer and performing sureness."The Canadian frugality is unsurprising to employ by 1.2 per cent in 2009, but the array sees a recovery in 2010, when the economy is sticking to alter by 3.8 per coin.Substantiate in October, the slope sticking ontogenesis of 0.6 per coin in 2009, and 3.4 per cent in 2010.The give module furnish author information on its looking for the economy on Thursday, when it releases its Monetary Contract Update.The finances also signalled that inflation fears somebody abated. The so-called set inflation assess is supposed to devolve to 1.1 per coin in the quartern somebody of this assemblage, time the coverall inflation rank is awaited to dip beneath cardinal for two lodging in 2009 because of modify vim prices.Condominiums Toronto
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