Bank of Canada Reduces Overnight Rate to 0.5%


Bank of Canada

What Happened?

In a hotly debated move, the Bank of Canada today announced that it was reducing it's overnight rate to 0.5%, down from 0.75% previously. (PDF)

Why Did it Happen?

It's the economy! It's slow right now. Unemployment is high in certain places (What the heck, Montreal? Get your act together!), and higher in Alberta than we're used to. Inflation has continued to be below the target 2% rate the Bank aims for, and the impact of lower oil prices throughout Alberta and the rest of Canada has been a drag on the economy.

What Will This Do?

The intent is to stimulate the economy by making borrowing cheaper so businesses - and consumers - can spend (sorry, invest) the economy back to life. Easier said than done, and not without potential pitfalls. Already low interest rates have been a boon to various housing markets throughout Canada though it remains to be seen whether or not this latest rate drop will further stimulate home buying.

Some of the risks of further stimulation in the economy are asset bubbles (could be houses, investments, etc.) because cheap borrowing makes it easier to qualify to buy expensive things. More demand for expensive things pushes prices up. When the cheap money goes away (someday, probably) it could cause less demand and certainly a greater supply of those assets on the market, which could lead to price corrections. Not always fun - it's better on the way up.

One of the greater risks of cheap money is high consumer debt levels. While affordability remains pretty good right now for a lot of people, that's only because interest rates are low. That could change in a hurry if/when rates prudent borrowing (and lending) is always encouraged.

What Will Not Happen?

Some social media commentators and industry experts are predicting that the Big Five Canadian banks, notably RBC, BMO, CIBC, TD, and Scotiabank, may not follow the Bank of Canada's lead and reduce their Prime lending rates the full quarter point. There is a precedent for not passing the full discount on to consumers: they've done it before with previous rate drops. As a mortgage broker this is a matter of great frustration for myself and my clients. The Bank of Canada's intended effect may be muted because of consumer banks capturing additional spread at their expense.

The additional quarter-point won't have a material impact on whether or not people qualify or not, but for those people who do have a mortgage, the lower interest rate (if you're in a variable or adjustable rate mortgage) could help you to pay down your debt faster.

What Does it Mean to Me? (And by Me, I mean You)

Well, if you're in the market to buy a home you may benefit by choosing a variable rate mortgage. It remains to be seen how this news will be received by the bond market, which more typically impacts fixed rate mortgages, but those could go down as well.

President of First Foundation Residential Mortgages and First Foundation Insurance. Live in Edmonton but cheer for the Riders. I have lots of kids. Follow me on Twitter @gordmccallum

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