After the weekend elections in Greece and France, the markets have reacted less than expected but they are still wary of potential future complications to the European Economic Union.  The election in France did not have much of an effect on the markets as the new leader, Francois Hollande, is considered to have fairly reasonable economic policies.  This may represent the end of the austerity movement to control the debt crisis but it seems that austerity driven economics was strangling any potential for economic growth.

The greater concern is the Greek government, or lack thereof, since no single party won enough seats to govern.  A coalition would require a few political parties to compromise on some principles and that does not appear likely at this time.  Greece appears headed towards another bailout or removal from the EEU.  Although Greece’s problems have already been factored in by the markets, this new development has refocused attention on the larger potential problems in Spain and possibly Italy.

These events will add to the list of external forces that the Bank of Canada will have to consider when deciding to increase the Prime rate.  If all other factors remain constant, the reoccurrence of the European debt problem should make the Bank of Canada wait longer than expected before increasing interest rates.   Although some pundits predict a 0.25% Prime rate increase this September, current events make a rate increase unlikely to happen until early 2013.

Fixed rates remain tremendously low with 5 year fixed terms around 3.29% for most Whistler properties and 10 year terms at 3.95% for most unrestricted properties.

The Canadian dollar slipped to just below par as the markets reacted to the European elections.  If the markets become convinced that the European debt crisis will return to previous crisis levels, the Canadian dollar could decrease significantly over the short term.  Investors will flee most currencies to buy up the US dollar currency to avoid being caught with devaluing currencies.  This fear driven flight to US dollars will cause the Canadian dollar to decrease over the short term.  This will provide non-resident buyers with an excellent opportunity to purchase Canadian assets at a discount, assuming that the buyers already hold US cash.  Long term prospects for the Canadian dollar remain strong.

Jason McLean  BSc, AMP
jason@garibaldimortgage.com

Comment (7)

Record levels of unemployment in Europe may lead to election upsets in Greece and France this weekend.  This has become a big concern for proponents of austerity in Europe since new leadership,

especially in France, will likely alter the current course of debt reduction that has been demanded by the larger European economies.    It remains to be seen whether this will prove to be the next step on the slippery slope towards nations leaving the European Economic Union and the abandonment of the euro.  If a major political party campaigns against austerity measures by stoking resentment towards other European nations, the next major election will surely see more parties leaning closer to policies that promote economic isolation and sovereign currencies.

In Canada, the GDP numbers for February showed a decline of 0.2% which should strengthen the case for the Bank of Canada to hold off on rate increases until the numbers improve.  If the European elections result in new governments that back out of previous economic agreements, we will likely see additional concern over global economic growth.  This will probably cause the Bank of Canada to hold off on rate increases until early 2013. 

The Canadian dollar remains above par and has shown decent strength over the past few weeks.  However, if the European election results scare the markets, we may see a decline as global investors rush to buy US currency vehicles as we did during the height of the European debt crisis.

Jason McLean  BSc, AMP
jason@garibaldimortgage.com  

Comment (13)

This week, the UK tipped back into a recession (which is technically two consecutive quarters of negative growth) after trying to battle the European debt issues with extreme austerity measures.   This is an example of how austerity measures can stifle economic growth just when it is most needed.  This leads us to the situation in the US, where tax cuts implemented by the Bush administration are set to expire at the beginning of 2013.   Although this will provide much needed revenue for the US, the expiration of the tax cuts will happen at the same time as $1 trillion in budget cuts take place.

These measures may, at first glance, appear to be just what the US needs to rise from the debt issues that have plagued it for the past few years.   However, as the UK has experienced, cutting budgets and increasing taxes at the wrong time will likely slow any existing growth and possibly reverse it to the point where another US recession is likely.  Some pundits are claiming that this situation poses as much risk to the global economy as the European debt debacle. 

The one wild card in all this is the US presidential election.  As with politicians of all stripes, promises will be made and a few of those might even be kept.  Changes in policy are inevitable when elections roll around so we will have to sit back and watch whether the potential US economic shutdown of 2013 comes to be.

Interest rates in Canada are experiencing some minor upwards pressure and rate increases of 0.1% to 0.2% may be seen over the next couple of weeks.

Despite a drop in oil prices, the Canadian dollar remained strong this week.  This is mostly due to expectations of the Prime rate increasing slightly by the end of the year.

Jason McLean  BSc, AMP
jason@garibaldimortgage.com 

Comment (20)

On Tuesday,  the Bank of Canada left the Prime rate unchanged for the 13^th consecutive meeting.   Mark Carney, the Governor of the Bank of Canada, used this meeting to hint at rate increases coming quicker than most might expect.  It is hard to say whether he was just trying to change public and market behavior with his comments or if he actually intends to begin the process of increasing rates before the end of the year.  Although the recent positive job numbers, reduced potential harm from the European debt crisis, and an improving US economy all lead towards a greater potential for higher rates, the Bank of Canada is in between a rock and a hard place.   The mere mention of potential rate increases caused the Canadian dollar to jump over one cent the day the speech was made.

Carney is increasingly concerned over the household debt levels in Canada and has repeatedly stated that this may be the biggest risk to Canada’s economic prosperity.   The problem is that if rates increase, and they will eventually, then there are a significant number of households that will be in financial difficulty as they are unable to afford increased debt payments caused by higher interest rates.   By increasing the Prime rate, the hope is that households will reduce their debt in preparation for higher rates.    However, increasing the rate will also increase the value of the Canadian dollar which will reduce exports and slow the economy down.    The Canadian dollar is also considered to be a quasi- petro dollar.  This means that due to Canada being a major oil exporter, increases in the value of oil lead to an increase in the value of the Canadian dollar. 

The only thing we know for sure is that rates will normalize eventually, and a normal Prime rate would probably be somewhere between 5% and 6.5%.   This is obviously a dramatic increase but the factors above mean that the Bank of Canada will have to walk a fine line between discouraging household debt & curbing inflation by increasing rates versus allowing the economy to grow by leaving rates alone for a while.  I am still predicting that rates will increase by 2% to 3% over the next five years but the timing and pace of the expected increases is too hard to predict at this time.

 Jason McLean  BSc, AMP
jason@garibaldimortgage.com

Comment (16)

As you have probably noticed recently, gas prices have increased fairly substantially in recent weeks.  I believe that the price at our local station is around $1.37/litre this week, about $0.10/litre higher than last year at this time. We are all affected by this whether we drive or not.   What you may not realize is how a single price item like gas can affect inflation and its corresponding effect on variable interest rates.

You may often  hear that the Bank of Canada has a target of 1.0% to 3.0% for core inflation, ideally right at 2.0%.  The Bank of Canada considers inflation as indicated by changes in the Consumer Price Index (CPI).  The CPI is essentially a comparison of the price of a standard set of products and services over time.  If the cumulative of this set of goods is higher than it was at some previous time, then inflation of the prices has occurred.  Core inflation represents the same set of goods but excluding the 8 most volatile components (fruit, vegetables, fuel oil, mortgage interest, gasoline, intercity transportation, tobacco products and natural gas).  The Bank of Canada uses the core inflation figure since theses 8 volatile products are less responsive to monetary policy and it allows for better forecasting over the long run.

Even though the changes in gas prices are excluded from the core inflation figures, gas is required to obtain almost everything else in the CPI set of goods.  Trucks deliver a large portion of the goods in our huge country.  The cost of shipping has to be built into the cost of most goods so this eventually leads to higher prices for the goods we buy.  The fuel surcharges that airlines charge is a variation of this example.

As gas prices increase, we will eventually see a knock on effect towards increased long term core inflation. 

Core inflation in February was 2.3% for the preceding year.  Although this is within the Bank of Canada’s target range, recent comments by Mark Carney indicate that growing concern over household debt levels may increase the likelihood that the Prime rate will be raised sooner than later.   This means that the goods we buy will eventually have to build in these increased costs of production. 

This is why I am expecting variable and fixed rate increases of at least 1.5% over the next 18 months, with a strong possibility of rates increasing by 2.5% to 3% over the next 4 years.

 Jason McLean  BSc, AMP
jason@garibaldimortgage.com

Comment (18)