Bank of Canada Maintains Rate At 1% – 10/25/2011


On 10/25/2011, The Bank of Canada (BoC) announced it will maintain its overnight interest rate at 1%. The Bank Rate is correspondingly 1.25% (1 1/4 percent) and the deposit rate is 0.75% (3/4 percent).  This is unchanged from the previous two announcements on July 19 2011, and September 7 2011 (which were uneventful and not mentioned on The Investment Blog).



The move reflects the central bank’s observation that the economy has “weakened since July” and will remain so a while longer:

• External environmental factors negatively affecting Canada (financial, confidence, trade channels).
• Domestic demand more subdued than previously anticipated.
• Household expenditures to grow modestly (lower commodity prices and increased financial market volatility weighing on the incomes, wealth and confidence).
• Solid business investment growth (from stimulative financial conditions) to be dampened by weaker and more uncertain economic environment.
• Weak exports with “sluggish foreign demand”, “competitiveness challenges”, and a strong Canadian dollar.

The Bank also revised and pushed back their expectations for the Canadian economy to return to full capacity by the end of 2013, given the weaker economic outlook.  It also “expects that growth in Canada will be slow through mid-2012” until the global economy improves and uncertainty fades, which would lead to increased confidence.



The BoC made the following observations on the global economy:

• Economy has slowed considerably due to several downside risks being realized.
• Financial market volatility has increased due to risk avoidance.
• Growth is expected to be restrained in advanced economies due to deleveraging (banks & households), fiscal austerity, and declining confidence.
• Expectations of a brief recession in Europe.
• GDP in the U.S. is expected to be weak due to declining confidence and tighter financial conditions.
• Increased growth in Japan will be driven by reconstruction activity over 2012-2013, but will be constrained by a decrease in global demand and the strength of the yen.
• Emerging market economies is expected to see moderate growth due to weak global demand and policy tightening.

The Bank also noted that it “expects that the euro area—where these dynamics are most acute—will experience a brief recession”. However, it warns that its assumption that the “euro-area crisis will be contained” is subject to downside risks.  The bank  also expects that moderate growth in the emerging markets and weaker global demand may “dampen global inflationary pressures”.

** I would like to note that investors should not ignore the risks present in the euro zone, and the probability of them being realized is likely higher than most would plan for.


Leaving Monetary Stimulus In Place

The Bank reiterated that maintaining the overnight rate will leave “considerable monetary policy stimulus in Canada” and that it will “continue to monitor carefully economic and financial developments in the Canadian and global economies, together with the evolution of risks, and set monetary policy”.

Impact to investors & individuals

Rates are still very low in Canada, providing an opportunity to secure relatively cheap credit (mortgages as well as other lines of credit).  Fixed rate mortgages (FRM) have recently decreased as the economy has continued to remain weak.  The 5yr closed rates are around 4.79% (with special rates around 4.09% – 4.30%).  Although variable rate mortgages (VRM) are not quite as attractive as they used to be (2- 3 years ago), most are around 3.00% (5yr closed) and 4.00% (5yr open), which are still considered low.

Within the last 6 months, both rates have dropped along with the corresponding government bond yields.   However, variable rates have experienced a sharp increase within the last 2 months, while fixed rates have continued to decline slightly.  It is likely that within the next 2 years both rates will rise significantly.   If you are looking for a long term loan (5 year mortgage), you will need to consider how much you would save with a VRM versus a FRM over the course of the entire 5 year term, with an increase expected sometime in the middle (and estimate the size and frequency of increases).

Tightening of credit has already begun, particularly in mortgage lending as we expected.  We can look forward to more credit tightening policies, even as rates continue to stay relatively low for a bit longer.  The BoC rates will not rise significantly until the economy is strong enough to support it.  During the past year, the economy has not been strong and therefore the low rates have been maintained.  Once the pace of economic recovery becomes healthier, increases of 0.25% would not be unexpected.  A single increase would not have too much of an impact to borrowing costs or cash flow.  However, remember that retail banks have and will raise rates before the BoC does.

The return on guaranteed investments have remained low, mirroring the low lending rates.  Most 1yr term deposits & GICs are yielding an anemic 0.70% – 1.50%, while 5yr GICs are yielding around 1.85% – 2.50%, and high interest savings accounts are offering rates of 1.50%.  Even the caps on market linked (or index linked) GICs are very low at around 10% (maximum return) for 3 and 5 yr terms.  Such low rates and cap limits, give very low annualized rates of return making them very unattractive.   We can expect the rates to remain relatively unchanged until economic conditions improve.  It is not recommended that investors lock in rates, given the likelihood that rates are expected to increase within 2 years time.  Savings accounts yielding approximately 1.50% is likely the better option for guaranteed investments at this time, allowing investors to remain flexible and benefit from any rate increases.  In regards to market linked GICs, current offers are more likely to yield small returns due to the low cap limits and the market risks for the 3yr and 5yr time horizons (from today’s date).

The Bank of Canada (October 25, 2011) announcement:

The Bank of Canada’s next scheduled date for announcing the overnight rate target is December 6, 2011.

Thanks and Happy Investing!  – The Investment Blogger © 2011


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