Mortgage rate forecast

Mortgage Rate Outlook

Mortgage rates have thus far evolved in-line with our December 2010 forecast, with the 5-year fixed rate reaching 5.44 per cent and the 1-year rate hitting 3.50 per cent in mid–February. Mortgage spreads (the difference between a fixed mortgage rate and the yield on Government of Canada bonds) have returned to historically normal levels and we expect these spreads to remain fairly stable in subsequent quarters. Therefore, the path of future mortgage rates will be largely determined by changes in government bond yields, which have moved significantly higher in recent months but are currently being pushed lower by world events. We anticipate that, barring a growth depressing and sustained rise in oil prices, yields will move gradually higher throughout the year as markets price in improving economic conditions and higher inflation expectations. Rising yields will in turn lead to higher mortgage rates, likely in the realm of 4.35 per cent for a 1-year and 5.90 per cent for a five-year fixed rate mortgage by the end of the year.

Growth and Inflation Outlook

Sentiment about the US economic outlook has improved dramatically in the two months since our last forecast. This is very good news for the Canadian economy and also very good timing as the economy is likely to face some headwinds in 2011 from potential consumer restraint, exchange rate pressure on exports and slowing residential construction. However, the increasingly positive economic outlook is already in danger of being swept aside by a looming crisis in the Middle-East and North Africa (MENA) region that is threatening spill-over to global markets and Canadian interest rates.

An improved outlook in the United States has prompted us to revise our forecast for Canadian real GDP growth from 2.1 per cent to 2.8 per cent in 2011, which we anticipate will be followed by 2.7 per cent growth in 2012. However, evolving geo-political events in the MENA region may provoke a re-assessment of growth expectations. While events in Egypt and Tunisia had little economic ramifications, potential disruptions to global oil supply from Libya and other oil-producing countries has the potential to prompt serious market disruptions through escalating oil prices.

The dynamics of how oil impacts the Canadian economy are complex. As an oil exporting country, higher energy prices can have a positive impact on growth. However, the negative impact of high oil prices is two-pronged. First, high oil prices (beyond $120 per barrel) have been shown to significantly reduce US economic growth. Moreover, the Canadian dollar has for years been tied to the price of oil. As oil rises, so too does the loonie, which may present a serious challenge for Canadian trade. Therefore, the negative impact of an oil shock likely outweighs any positive effects for the Canadian economy.

Regarding inflation, our view remains that inflation is not likely to be a problem in the medium term. However, inflation expectations have ticked higher in recent months, a result of both positive incoming economic data and some pricing pressure from soaring food and energy prices. So far, the sharply higher food and energy prices that have been pushing headline CPI inflation higher have not found their way through to core-measures of inflation watched by Central Banks. Moreover, as an oil producing country, much of the inflationary impact of an increase in energy prices tends to be offset by an appreciation in the loonie – which has hit a three-year high of $1.03 US as oil prices pushed over $100 US per barrel.

Interest Rate Outlook

As expected, the Bank of Canada held its overnight rate at 1 per cent at its March 1st meeting. In the absence of nascent geo-political risk and the soaring loonie, the stronger than expected pace of economic growth may have alone been enough to push the Bank to raise rates at its next meeting in April. However, the risk posed to the global economy by a still evolving situation in the MENA region along with the anti-inflationary (and potentially growth-subduing) impact of the loonie’s rise will likely see the Bank erring on the side of caution and therefore holding rates steady until the summer. Once the Bank resumes rate increases, we expect the overnight rate to rise from one per cent to between 1.75 and 2 per cent by end of 2011.

A much improved economic outlook has prompted a steepening of both the Canadian and US yield curves, with large movements occurring in the 5-10 year maturities. However, some of the increase has been offset by growing risk aversion as investors flee back into safe assets to wait out events in the MENA region. The unpredictability (in both the severity and duration) of this still developing situation should translate to volatility in bond yields going forward, but we maintain that Canadian interest rates will ultimately end the year higher.

Source: British Columbia Real Estate Association

Mortgage Rate Outlook

Mortgage rates have thus far evolved in-line with our December 2010 forecast, with the 5-year fixed rate reaching 5.44 per cent and the 1-year rate hitting 3.50 per cent in mid–February. Mortgage spreads (the difference between a fixed mortgage rate and the yield on Government of Canada bonds) have returned to historically normal levels and we expect these spreads to remain fairly stable in subsequent quarters. Therefore, the path of future mortgage rates will be largely determined by changes in government bond yields, which have moved significantly higher in recent months but are currently being pushed lower by world events. We anticipate that, barring a growth depressing and sustained rise in oil prices, yields will move gradually higher throughout the year as markets price in improving economic conditions and higher inflation expectations. Rising yields will in turn lead to higher mortgage rates, likely in the realm of 4.35 per cent for a 1-year and 5.90 per cent for a five-year fixed rate mortgage by the end of the year.

Growth and Inflation Outlook

Sentiment about the US economic outlook has improved dramatically in the two months since our last forecast. This is very good news for the Canadian economy and also very good timing as the economy is likely to face some headwinds in 2011 from potential consumer restraint, exchange rate pressure on exports and slowing residential construction. However, the increasingly positive economic outlook is already in danger of being swept aside by a looming crisis in the Middle-East and North Africa (MENA) region that is threatening spill-over to global markets and Canadian interest rates.

An improved outlook in the United States has prompted us to revise our forecast for Canadian real GDP growth from 2.1 per cent to 2.8 per cent in 2011, which we anticipate will be followed by 2.7 per cent growth in 2012. However, evolving geo-political events in the MENA region may provoke a re-assessment of growth expectations. While events in Egypt and Tunisia had little economic ramifications, potential disruptions to global oil supply from Libya and other oil-producing countries has the potential to prompt serious market disruptions through escalating oil prices.

The dynamics of how oil impacts the Canadian economy are complex. As an oil exporting country, higher energy prices can have a positive impact on growth. However, the negative impact of high oil prices is two-pronged. First, high oil prices (beyond $120 per barrel) have been shown to significantly reduce US economic growth. Moreover, the Canadian dollar has for years been tied to the price of oil. As oil rises, so too does the loonie, which may present a serious challenge for Canadian trade. Therefore, the negative impact of an oil shock likely outweighs any positive effects for the Canadian economy.

Regarding inflation, our view remains that inflation is not likely to be a problem in the medium term. However, inflation expectations have ticked higher in recent months, a result of both positive incoming economic data and some pricing pressure from soaring food and energy prices. So far, the sharply higher food and energy prices that have been pushing headline CPI inflation higher have not found their way through to core-measures of inflation watched by Central Banks. Moreover, as an oil producing country, much of the inflationary impact of an increase in energy prices tends to be offset by an appreciation in the loonie – which has hit a three-year high of $1.03 US as oil prices pushed over $100 US per barrel.

Interest Rate Outlook

As expected, the Bank of Canada held its overnight rate at 1 per cent at its March 1st meeting. In the absence of nascent geo-political risk and the soaring loonie, the stronger than expected pace of economic growth may have alone been enough to push the Bank to raise rates at its next meeting in April. However, the risk posed to the global economy by a still evolving situation in the MENA region along with the anti-inflationary (and potentially growth-subduing) impact of the loonie’s rise will likely see the Bank erring on the side of caution and therefore holding rates steady until the summer. Once the Bank resumes rate increases, we expect the overnight rate to rise from one per cent to between 1.75 and 2 per cent by end of 2011.

A much improved economic outlook has prompted a steepening of both the Canadian and US yield curves, with large movements occurring in the 5-10 year maturities. However, some of the increase has been offset by growing risk aversion as investors flee back into safe assets to wait out events in the MENA region. The unpredictability (in both the severity and duration) of this still developing situation should translate to volatility in bond yields going forward, but we maintain that Canadian interest rates will ultimately end the year higher.

Source: British Columbia Real Estate Association