BoC Rate Guidance: Use with Care

THINK OUTSIDE THE BOX:  The Bank of Canada exudes credibility. It’s an internationally respected central bank, it operates with minimal political interference and it has contained inflation for 22 years.
So when a Bank Governor gets surprisingly hawkish, we immediately see headlines like “Interest rates expected to increase.” Thousands of mortgagors key off those headlines and scramble to lock in fixed rates.
That very thing started happening in April 2012. But, as this Yahoo! Finance story points out, Canadians paid a price if they heeded Mark Carney’s 2012 warnings and locked in.
Take a homeowner with a $300,000 variable mortgage at prime – 0.50, for example. By acting on the BoC’s 2012 rate guidance and converting to a 3.25% five-year fixed (a typical rate back then), it would have cost over $3,800 of extra interest…and counting.*
If economists are right and rates don’t rise for another year, that person will have paid $6,000 of extra interest by abandoning his/her variable rate.
Of course, rate decisions are child’s play in hindsight. But this nonetheless demonstrates how basing mortgage decisions on someone else’s crystal ball (even the Bank of Canada’s), is seldom more than gambling.
One instance where the Bank of Canada’s guidance seems consistently predictive is when it hints of imminent rate changes. Here is just such a statement from 2005:
“…reduction in the amount of monetary stimulus will be required in the near term…”
Note the phrase “near term.” The BoC hiked rates two months after this statement.
By contrast, when the Bank declares that “someday” or “eventually” rates will go up, you might as well use a magic 8-ball to select your term. As we’ve seen since 2009, “someday” can be pushed back for years, literally.
Thankfully, current BoC governor Stephen Poloz appears more realistic about the Bank’s rate forecasting ability than his predecessor. The result is less chatter about rate expectations.
“All we are really doing is being honest and saying that at this stage, rates will stay where they are for quite some time,” said Poloz. (Src: WSJ) “…Issuing a warning that they are almost ready to go up—it’s not the right timing.”
“Of course we believe [rate hikes] will happen as the story unfolds but the destination seems far enough away that we can address that as we get closer.” (Src: Canadian Business)
* Based on a 25-year amortization.

December 16, 2013

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