The Bank of Canada held its benchmark overnight lending rate steady at 4.25 per cent on December 5th. The trend-setting Bank rate, which is set 0.25 percentage points above the overnight lending rate, remains at 4.5 per cent. CREA expects interest rates to remain on hold until the spring.
The rate was raised seven times by 0.25 per cent from September 2005 until it was put on hold in July 2006. "The current level of the target for the overnight rate is judged at this time to be consistent with achieving the inflation target over the medium term," said the Bank in its December statement. This is the same statement the Bank made in July, September and October 2006.
The Bank recently revised its forecast for economic growth downward. The statement regarding its most recent decision to hold interest rates steady acknowledged, "Some recent indicators suggest that output growth in Canada and the United States in the fourth quarter of 2006 may be a little weaker than previously expected."
Upward pressure on inflation normally eases when current economic growth comes in weaker than previous Bank of Canada forecasts, and below what the Bank considers to be its full potential. The Bank's Monetary Policy Update – to be released on January 18 th 2007 – will likely update its views on whether the economy is slowing faster than it previously forecast.
"The decision by the Bank of Canada to hold interest rates steady was widely expected," said CREA Chief Economist Gregory Klump.
Looking ahead, the Bank repeated its assessment of risks to the inflation outlook it published in September. "The main upside risk relates to the momentum in household spending and housing prices. The main downside risk is that the U.S. economy could slow more sharply than expected, leading to lower Canadian exports." In the Bank's view, risks around its inflation projection remain "roughly balanced".
"If the Canadian economy slows faster than it forecast in its Monetary Policy Report published in October 2007, interest rates could ease slightly in the spring," said Klump. "Inflation is currently in sync with the Bank's projection, but it is keeping a close eye on the evolution of those risks."
"Economic growth is being supported by continuing strength in domestic demand, while being undercut by weakness in net trade. Slowing U.S. economic growth may tip the balance, and translate into a cut in interest rates of 0.5 per cent in the first half of next year," Klump noted.
Bonds respond to expectations about inflation and economic growth, and mortgage rates track bond yields. "The bond market has already priced in a downshift in economic growth due to weakening Canadian exports to the U.S," said Klump. "That has already caused the five-year conventional mortgage to retreat from its peak of last summer. The five-year conventional mortgage rate may ease slightly in the coming months, and remain below seven per cent over 2007."
When the Bank decided to keep interest rates steady on December 5th, the advertised conventional five-year conventional mortgage rate stood at 6.5 per cent – down 0.40 per cent compared to mid-August. Competition among mortgage lenders remains stiff, which continues to help many borrowers negotiate discounts of one per cent or more off advertised rates.
"An increase in new listings and recent home price increases are forecast to prompt some homebuyers to shop longer before making a purchase decision, and gradually cool housing activity over the rest of the year and in 2007," Klump added.
Record level sales activity in the first 10 months of 2006 is expected to help lift MLS® residential transactions to their sixth annual record in 2006. Additional price increases are forecast to push the MLS® residential average price to the highest level on record. Source: The CREAstats - National
