The Bank of Canada surprised us all last week by cutting their Overnight Lending Rate by 25 basis points. No one saw it coming and from what I understand it sent trade floors into a state of panic. Until now, economists were convinced the rate hike would be coming by the end of the year and were telling Canadians to brace for more expensive borrowing costs. In the last few months I have written extensively about the possibly of a rate hike in my weekly blogs here and here. This new development will change the course of everything we were predicting for 2015: from forecasts on mortgage rates, to housing prices, to employment, they all need a revision.
Housing Prices to Reach New Peaks
The luckiest person would have bought a house days before the rate cut announcement and is now getting ready to sell the home they live in. With the busy spring housing season ahead of us, real estate prices are going to rise. The rate cut has given debt-laden Canadians more reason to stay that way. That sentiment is sure to push prices further as homebuyers are willing to pay even more for their dream home.
The average price of a home in Canada in December 2014 was $405, 233. The rate cut will absolutely push this average higher. Great for home sellers, but more discouraging news for new homebuyers – especially those who have been waiting for prices to fall before getting into the market.
Mortgage Rates: Wait and See
As suspected, banks will probably adjust prime to reflect the Bank of Canada’s rate cut. Some banks, like TD, are suggesting they have to look at all factors before they cut their prime rate. But it would only take the move of one bank to bring the prime rate down across every financial institution in the country. If you have a variable rate mortgage you will see your cost of borrowing come down as a result. As well, if you’re shopping for a home the bank will be able to offer you lower fixed and variable rate options. If you’re holding any kind of floating rate loan, my suggestion would be that you keep the same payment schedule and not lower your payments. This means more of you money will be going towards principal and getting you out of debt quicker than before.
Employment to Take a Hit
One of the BoC’s reasons for cutting the overnight lending rate was to counter the impact of lower oil prices on our economy. Bank of Canada Governor Stephen Poloz stated after the interest rate announcement, “The drop in oil prices is unambiguously negative for the Canadian economy. Canada’s income from oil exports will be reduced, and investment and employment in the energy sector are already being cut.” In the last week thousands of layoffs have been announced at oil-field service company Baker Hughes and its rival Schlumberger Ltd. Suncor also announced its cutting 1,000 jobs from its workforce and more layoffs are expected in Alberta’s oil and gas sector. Cutting rates has sent our dollar lower and could be the short term reprieve Canadians companies need to avoid job cuts.
Debt Levels Could Get Dangerous
Lower rates will mean more incentive for Canadians to borrow and go into deeper debt. Poloz voiced those concerns in his statement after the rate cut saying, “While it is true that a lower profile for interest rates may exacerbate household imbalances at the margin by encouraging more borrowing, the far more important effect will be to mitigate those imbalances by cushioning the decline in income and employment caused by lower oil prices.”
What Should Consumers Do?
At this time Canadians should be taking advantage of the lower cost of borrowing by paying it off more aggressively. There is indication that a lower interest rate environment is the new norm, but regardless, carrying large amount of debt will stifle homeowners’ opportunity to do more with their money. Getting a car loan, or a loan to renovate your home is impossible if your debt-to-income ratio is too high. As well, having a large amount of debt at any interest rate can limit your opportunities to save money for you retirement, your child’s education and other long term goals.