Bank of Canada rate cut unlikely to lower mortgage, loan rates much

Canadians looking for a break on their mortgage or credit loans may be disappointed that none of Canada's major banks are passing along the full savings. Still, this may be a good thing for Canada's overheated housing market, some say.

Interest rates expected to rise again in 2016

The Bank of Canada lowered its benchmark interest rate Wednesday, hoping to stimulate the economy while avoiding adding to Canadians' debt levels or creating a housing bubble. (Mark Blinch/Reuters)

Canadians hoping for a big break on their mortgage, or cheaper cash on their lines of credit may be disappointed.

Economists say it is unlikely the major banks will match the Bank of Canada's second benchmark interest rate cut this year. Instead, they appear poised to pocket much of the savings and pass only a portion down to consumers.

The central bank is clearly hoping to stimulate the economy while avoiding adding to Canadians' already troublesome debt levels, says Angelo Melino, a University of Toronto economics professor and former special adviser to the Bank of Canada.

As a result, the major banks response will likely "be muted," says Melino. 

"There'll be some encouragement to borrow more, but it won't be as much as you usually get from a cut."

Slight decrease to prime lending rates

The Bank of Canada announced Wednesday it lowered its benchmark interest rate to 0.5 per cent. In January, it surprised analysts and slashed its interest rate by a quarter of a percentage point, down to 0.75 per cent, after sitting at one per cent for nearly five years.

The central bank's rate sets the interest rate for money that the major banks and other institutions lend to one another for one-day periods.

Banks aren't required to match any changes from the central bank in their prime lending rates. But they've generally followed suit, passing on their borrowing savings, or costs if the benchmark rate is raised, to consumers. 

Variable-rate mortgages and lines of credit are generally tied to a bank's prime interest rate. Fixed mortgage rates, on the other hand, are linked to long-term government bond yields, which may react to the central bank's interest rate cut over time.

After January's surprise drop of 25 basis points, the country's major banks declined to lower their rates by the same amount. Instead, over the course of a week, all five lowered their prime lending rates by 15 basis points, just a little over half.

Analysts say the banks aren't likely to change that strategy this time.

Indeed, TD Canada Trust made the first move on Wednesday, decreasing its prime lending rate by only 10 basis points.

TD rushed to "set the trend" for how its competitors will react, says Penelope Graham, an editor at, a website that compares lending rates. 

She anticipates others will follow suit. One or more banks may try to create a "competitive skirmish" by offering a slightly larger reduction, she predicted, which the Royal Bank in fact did later in the day yesterday, lowering its prime lending rate by 15 basis points. 

The Bank of Montreal, Scotiabank and CIBC followed suit later Wednesday evening. TD held out until late Wednesday evening, when it lowered its prime lending rate by another 5 basis points, joining the other major banks at 2.7 per cent.

Near-zero interest rates already

While banks typically mimic the central bank's rate changes, analysts say already record-low interest rates leave financial institutions with little wiggle room for offering the same 25 basis point decrease.

Bank of Canada Governor Stephen Poloz surprised analysts in January by dropping the interest rate by 25 basis points after it had sat at one per cent for nearly five years. (Chris Wattie/Reuters)
Before the Bank of Canada cut yesterday, the banks all listed their prime lending rate at 2.85 per cent. "So, they don't have a lot of room to really make a move," says Graham. 

Banks are already struggling, says Laurence Booth, a professor of finance at the University of Toronto's Rotman School of Management. He thought the Bank of Canada's second rate reduction was unnecessary.

Some of Canada's banks have been reporting strong profits recently. TDRBC and CIBC all exceeded their earnings expectations in their most recent reports.

But, with rock bottom lending rates, the difference between what banks pay on deposits versus what they lend out is getting squeezed, says Booth, and this profit squeeze has been reflected in bank share prices recently.

"The financial sector in Canada has been pretty weak," he says. "They're waiting for interest rates to go up."

High household debts a concern

One of the risks of a central bank rate cut is that it might encourage more household borrowing.

Canadians already have high debt loads. The average household owes more than $92,000, including mortgage debt, according to a new poll. Canadians debt-to-income ratio sits at 163.3 per cent, meaning that Canadians owe $1.63 for every $1 in disposable income they earn in a year.

"People who are really seriously in debt, this basically encourages them to keep the debt that they've already got and possibly borrow some more money" to, say, buy a bigger home or enter the housing market, says Booth.

It could propel housing prices in possibly over-heated markets like Toronto and Vancouver even higher, he says, which could lead to difficulties later.

"The problem is that sooner or later those interest rates are going to go back up."

Interest rates ready to rise soon

Those rises are expected as early as next year.

The Bank of Canada announces rate changes eight times a year, and most observers seem to feel it is unlikely to raise rates on its next set date, September 9, as this would be in the midst of a federal election.

"But I wouldn't be surprised if they didn't start to rise again in 2016 — in early 2016," Melino says.

The Bank of Canada is now forecasting a slight economic recovery over the second half of the year, which "will set the tone" for hiking rates, says Graham.

As well, the U.S. Federal Reserve seems poised to raise its rate, which analysts say tends to impact Canadian mortgage or other long-term debt interest rates, as well as the Canadian dollar. It dropped to its lowest level since the financial crisis yesterday as a result of the Bank of Canada move, and would likely drop again if the U.S. raises its interest rates in the fall.

Melino says the drop in the dollar is probably what the Bank of Canada was hoping to achieve by yesterday's cut, in order to help exporters.

But Graham cautions that anyone considering taking advantage of today's slightly lower lending rates should not rely on these rates sticking around in the future and should probably keep a two to three per cent buffer in their budget for when rates rise.

"If you take out a five-year fixed mortgage rate today, you're going to be looking at, quite potentially, higher rates come renewal time," she says. "Don't tap yourself out when you're borrowing. Don't rely on these record low rates."