by Peter Kinch
As I flipped through the business papers recently, I was struck by a sense of having seen these headlines before: Contagion Fears in Greece, Household Debts on the Rise, Brace for a Shock, No Easy Exit for U.S. Housing Market, Housing Bubble Fears, U.S. Recovery Hits the Skids, and European Debt Crisis.
A year ago, I wrote an article that said no one would blame you if you were overcome with a pending sense of doom just by reading the headlines. Here we are a year later and I feel like I can pull out the same story and just change the date on it. Once again, we find ourselves in a situation where simply reading the headlines is enough to make optimists feel pessimistic about where the economy is heading.
Mark Carney, governor of the Bank of Canada, when speaking to the Vancouver Board of Trade, issued warnings that there is a risk that “fear and greed” are driving real estate prices to unsustainable levels. At the same time, Ben Bernake, Carney’s counterpart with the U.S. Fed, was preparing to put an end to an unprecedented era of quantitative easing in the U.S. — meaning the U.S. government was going to stop printing money to bail out bad loans. And while a group of undesirables in Vancouver used the loss of a hockey game as an excuse to riot in the streets, 80,000 people in Athens prepare to riot in protest of proposed government austerity programs aimed at preventing the country from going bankrupt and defaulting on its debt.
What does all this mean to you as a Canadian homeowner?
For most consumers, who either have a mortgage or are looking to get one, the question inevitably comes back to: How does all of this impact interest rates?
The answer lies slightly beyond the headlines.
It is no secret that the current low interest rate environment that we’ve been enjoying for the past three years must come to an end eventually and start to make its way upwards to what is referred to as a “neutral” rate zone of a prime rate at five to six per cent.
The age-old (or in this case three-year-old) question is not if, but when? Canada’s central bank is trying its best to suggest those rate increases could be sooner rather than later. It has used particularly strong language to warn Canadians about the impending rate hikes. Carney repeated his warning to Canadians about becoming overextended.
“It’s important that it’s emphasized,” said Carney, because it can be forgotten that we are living in extraordinary times with interest rates that are unusually low ... that rates are not going to stay at these unusually low levels. And so Canadians need to ensure that they can continue to service those debts comfortably in a higher-rate environment.”
It’s clear that Carney is starting to show some frustration that, although he’s been warning against Canadians taking on too much debt at these low rates for more than two years now, his words appear to be falling on deaf ears. House prices have risen in most Canadian cities (Calgary and Edmonton being the rare exceptions) by an average of 8.6 per cent, with Vancouver leading the way at a year-over-year increase of 25.7 per cent. Combined with a record level of household consumer debt fuelled by a prolonged period of record low rates, it’s no wonder that the Bank of Canada feels Canadians are not getting the message.
But this is where it gets interesting. Given his comments, one would expect the Bank of Canada to begin raising rates soon in an effort to cool the housing market. But it’s not that easy. We still have to look at what’s happening south of the border. The Fed was scheduled to put an end to quantitative easing on June 30. However, Bernake made it clear in recent comments that, although he will stop the asset purchase program that was designed to help get the U.S. economy back up on its feet, slower than expected job growth has resulted in the need for continued monetary stimulus in the U.S. economy, which is lacking a confident consumer base to pull it out of its recession. This translates to a further extension of low rates in the U.S.
It now appears that Bernake will not make a move in rates until 2012.
Carney has said that Canada cannot deviate too much for too long from the U.S. because of the effect that would have on the Canadian dollar.
So, essentially we have a situation whereby the Bank of Canada would like to raise rates to slow down our borrowing habits, but to do so would mean a separate monetary policy than the United States, and cause the Canadian dollar to rise and potentially hinder the economic recovery as a whole.
Further compounding Carney’s dilemma (especially in the Vancouver market) is the influence of foreign investors who represent a key driver behind the surging market values. Raising rates will have little or no impact on those buyers and will serve only to hurt the domestic buyer.
So Carney may look to Jim Flaherty and the Finance Department again to provide the solution as he has for the past two years. Having the Finance Department make it more difficult for some Canadians to get a mortgage may be a more appropriate tool than to raise rates.
As we enter the third quarter of 2011, we find ourselves in territory similar to where we were in 2010. We know rates have to start going up, but certain factors keep preventing them from doing so: the stalled US recovery, global uncertainty, European debt crisis and the Canadian dollar.
Rates eventually will go up, but in the meantime, we continue to benefit from yet another prolonged low-rate environment.
My warning to you is the same as it was a year ago. The market has presented you a gift, so how are you going to use it?
In the midst of all this talk about the Bank of Canada, one very important element gets missed. The bank can control only the prime lending rates. The long-term rates are governed by the bond markets. A drop in bond yields has resulted in another wave of record low long-term rates as well.
If all this talk of global uncertainty concerns you, or you simply don’t want to have to guess what Carney’s next move is going to be, there has never been a better time to lock into a long-term rate and simply forget about it, knowing that you have a fixed low cost of borrowing and you can sleep well at night.
For the rest of you, stay tuned. There’s bound to be more exciting headlines to share in the months ahead.
(Peter is founder and owner of the Peter Kinch Mortgage Team and the PK-Approved group of Dominion Lending Centres mortgage brokers across Canada, and co-owner of the Pacific Bridge Mortgage Investment Corp. The article above first appeared in the New Home Guide.)