Within hours of the Bank of Canada’s announcement that they had cut the overnight rate down by 50 basis points to 1.25% several big banks followed suit. It was uncertain whether the banks would move in lockstep with this announcement, but they have.
The Bank of Canada’s move was not predicted by speculators, but is largely believed to have been prompted by the US Federal Reserve’s rate cut of the same amount the day before. The Bank stated that the coronavirus and its impact on the Canadian economy was a core factor for the decision. However, big banks did not cite the Bank of Canada’s move or the virus in their decisions to cut rates as well.
It is believed that the Fed cut rates in an attempt to trigger a rebound in the stock market, which would have improved fixed mortgage rates, but the attempt seems to have failed. In fact, some analysts suspect the move may have actually frighted off investors.
Although rate cuts are good for mortgage lenders (and anybody else with a loan) because it means they can borrow more and pay less, it’s uncertain whether this was really a good economic move by the government.
“Monetary policy is generally not highly effective in resolving supply-side shocks,” TD economist Beata Caranci wrote in a report on Monday. Fiscal policy, on the other hand, is effective “when targeted at the source of the supply shock,” she added. This means that because of the change in monetary policy, prospective homeowners might have more buying power, but a change in fiscal policy is what’s going to increase the number of houses available in the market.
- Monetary policy involves changing the interest rate and influencing the money supply.
- Fiscal policy involves the government changing tax rates and levels of government spending to influence aggregate demand in the economy. [https://www.economicshelp.org]
“Clearly, the Bank is making a big tradeoff here, deciding that the risks of a virus-driven slowdown are much higher than the risks of a raging housing market,” BMO chief economist Douglas Porter wrote in a note to clients. Mike Eppel, Senior Business Editor of 680 News, disagrees. He says that yes, it might add fuel to the fire but “it’s likely just going to be another thing that will help the housing market to the upside this Spring.”
With low rates it’s expected that banks will get rid of discounts. And the more the bond yield drops (which determines fixed mortgage rates) the greater the indication our economy is headed into the toilet. If we head into a recession it’s likely Canada will drop its leading rate to 0%. The Bank of Canada will make its next announcement on the overnight rate in April. Stay tuned.