Why don`t fixed rates fall when the Central bank lower`s their key lending rate?
This week the Bank of Canada lowered their key lending rate to 0.50%, this is the lowest rate in Canadian history. Many banks followed immediately by lowering their prime rates to 2.50% which have affected variable mortgage rates accordingly but not fixed rates. This is because the key lending rate is not “correlated” (or linked) to fixed mortgage rates. Rather fixed mortgage rates are typically linked to the Canadian Bond Market.
Actually, the bond market is not at all tied to rate cuts by the bank, but rather to the economy. If the Canadian latest economic news and statistics were strong then the bond yields would increase and actually force the fixed rates upward. This could actually happen while the Bank of Canada cut rates. As such variables could drop and fixed rates could increase. The 5 year Government of Canada Bond can actually be a good predictor of how mortgage rates will perform.
But that is only half the story as the Chartered Banks and the major lending institutions in Canada also have a large factor in determining these rates. How competitive they choose to be and how much risk they want to assume.
The Canadian Business magazine explains in an article in June 2004 –
“The chartered banks set their mortgage rates based on yields in the bond market. A Government of Canada bond represents a risk free investment to the banks. If the banks choose to invest in a mortgage, they are taking on added risk and incurring costs to set up and service it. The banks will set their mortgage rates high enough above the equivalent bond yield to cover their costs and provide some sort of profit margin for the added risk they are taking on. Over the past decade the spread above the equivalent bond yield has narrowed as the competition for mortgage business has intensified between the big banks.” To read the full article click here
What to take from this…if you are considering whether to refinance or get your first mortgage, this is the time. Fixed rates are at all-time lows, the 5 year bond yield is currently holding around 1.90% which is also very low. There isn’t much room for the rate to decrease and latest economic reports indicate that the Canadian economy could turn around as early as the first quarter of 2010.
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