Bank rate held steady in January

The Bank of Canada held its benchmark overnight lending rate steady at 4.25 per cent on January 16th. The trend-setting Bank rate, which is set 0.25 percentage points above the overnight lending rate, remains at 4.5 per cent. CREA expects interest rates to remain on hold until the late spring.

The rate was raised seven times by 0.25 per cent between September 2005 and July 2006. “The current level of the target for the overnight rate is judged, at this time, to be consistent with achieving the inflation target over the medium term,” said the Bank in its January statement. This is the same statement the Bank made last July, September October and December.

Inflationary pressures normally ease when economic growth slips below its potential. The Bank acknowledged that growth has slowed, but expects that growth will rebound in the absence of interest rate cuts. “The Bank projects that economic growth in Canada will pick up to about 2.5 per cent in the first half of 2007, and that the economy will continue to operate near its production capacity throughout 2007 and 2008.“

“The decision by the Bank of Canada to hold interest rates steady was widely expected,” said CREA Chief Economist Gregory Klump.

Looking ahead, the Bank repeated its assessment of risks to the inflation outlook it published toward the end of last year. In the Bank’s view, risks around its inflation projection remain “roughly balanced”, but “the main upside and downside risks remain roughly balanced.”

“Interest rates may ease slightly in the spring if the Canadian economy slows faster than the Bank of Canada expects in its recent upbeat assessment of growth prospects,” said Klump. “Inflation is currently in sync with the Bank’s projection, but it is keeping a close eye on the evolution of those risks.”

“Strong personal income growth has buoyed U.S. consumer spending, but there will likely be some moderation in spending as falling home prices cuts into the growth rate of household wealth. This link remains the key risk to the Canadian economic outlook. If U.S. consumer spending slows by more than expected, the Bank will be forced to acknowledge a greater downside risk to their economic outlook. That could translate into a cut in interest rates of 0.25 per cent in April or May,” Klump noted.

Bonds respond to expectations about inflation and economic growth, and mortgage rates track bond yields. “The bond market has already priced in a downshift in economic growth due to weaker economic growth,” said Klump. “That has already caused the five-year conventional mortgage to retreat from its peak of last summer, and is forecast to remain below seven per cent over 2007.”

When the Bank decided to keep interest rates steady on January 16^th, the advertised conventional five-year conventional mortgage rate stood at 6.4 per cent – down 0.55 per cent compared to its peak last year. Competition among mortgage lenders remains stiff, which continues to help many borrowers negotiate discounts of one per cent or more off advertised rates.

“An increase in new listings and recent home price increases are forecast to prompt some homebuyers to shop longer before making a purchase decision, and gradually cool housing demand over 2007,” Klump added.

MLS® residential transactions in Canada’s major markets last year ran virtually even with record levels the year before, and average price set another annual record. Additional price increases are forecast to push the MLS® residential average price to new heights in 2007.