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Mortgage rate outlook
Long-term interest rates have remained near their lowest levels of the year for most the second half of 2014, even in the face of an improved outlook for economic growth and higher inflation. The five-year Government of Canada bond yield, the benchmark for the five-year mortgage-qualifying rate, has trended at or below 1.5 per cent for much of the year. Indeed, for the past several years interest rates have frustrated forecasters predicting an imminent normalization.Persistently low long-term bond yields can be partially explained by factors such as an aging population and associated slowing of potential economic growth as well as increased demand by foreign investors for safe Canadian assets. Ultimately, what may be keeping long-term bond yields and mortgages rates near historic lows is a lack of confidence in the sustainability of economic recovery. If so, an important catalyst for an eventual normalization of interest rates is some signal to markets that the US economy has finally healed. The best candidate for such a signal is the US Federal Reserve tightening monetary policy following six years holding the federal funds rate at zero.
Most forecasters have penciled in a Fed rate hike in the spring of 2015, with the Bank of Canada following later in the fall. However, there may be ample reasons for the Fed to stay on hold in 2015. First, US economic growth forecasts have been notoriously optimistic since the end of the Global Financial Crisis. Indeed, while the US economy is currently posting its strongest growth in years, global economic growth seems to be deteriorating as Europe struggles and China slows. Any disruption in global financial markets stemming from those economies would likely delay a move by the Fed. Moreover, inflation in the United States is already running well below the Fed’s target of 2 per cent and should track lower due to falling energy prices.
That said, our baseline forecast remains tilted toward a probable rate increase by both the Fed and the Bank of Canada in 2015. Long-term interest rates will likely move modestly higher beginning in early to mid-2015 in anticipation of monetary tightening, which should put some upward pressure on mortgage rates. We expect that the five-year fixed rate will average 5.15 per cent in 2015 and the one-year rate will average 3.29 per cent.
Economic outlook
The Canadian economy was hammered by severe winter weather to start the year but has since posted average quarterly growth of over 3 per cent. Indeed, the outlook for growth in the Canadian economy is as bright as it has been in years. That said, the recent dramatic downturn in oil prices will very likely trim growth in coming quarters.
While lower prices for gas and other energy goods may be seen as positive, untangling the macroeconomic consequences of declining oil prices can be complex for an oil-producing country like Canada. The Canadian dollar is implicitly tethered to the price of oil, and has trended lower alongside oil prices. That decline will act as a shock absorber, boosting Canadian export competiveness. On the downside, dramatically lower oil prices will be felt immediately though Canada’s terms of trade as the value of Canadian exports is dragged lower by energy goods.
If low oil prices persist, investment, output and employment in the Canadian oil and gas sector could be in jeopardy as well. Fortunately, other parts of the Canadian economy continue to prosper. In particular, momentum in business investment and non-energy exports has been growing and should provide a decent handoff to 2015. Overall, we anticipate that the Canadian economy will match 2014’s estimated growth of 2.4 per cent next year before decelerating slightly to 2.3 per cent in 2016.
Interest rate outlook
In its most recent interest rate decision, the Bank of Canada emphasized that the Canadian economy is as healthy as it has been in many years. Faster than expected economic growth in 2014 has helped close much of the Canadian output gap, and the economy is on track to return to its full employment level faster than previously expected.With inflation trending above 2 per cent and the economy accelerating, we would normally expect to see some tightening of interest rates from the Bank of Canada. However, the Bank remains reticent. One reason is that although the Canadian unemployment rate has fallen to its lowest level in six years, both total hours worked and average wages have not registered the type of gains we would normally see in a thriving economy. Indeed, the Bank of Canada cited excess slack in labour markets as the key offset to an otherwise very healthy economy.
Additionally, the steep decline in the price of oil, if sustained, will be a significant headwind for both growth and inflation next year. Our model simulations show that a sustained drop in the price of oil will delay the closing of the Canadian output gap by several months. Given these factors, if the Bank does decide to raise its overnight rate in 2015, we expect that it would not occur until the later part of 2015.
Copyright British Columbia Real Estate Association. Reprinted with permission.
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