Mortgage, Money and Dream – Our thoughts on Canadian Mortgage Market
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boc-overnight-rate-forecast-august-2013Bank of Canada manages the overnight lending rates between banks. It oversees the interbank lending through its large value transfer mechanism (Large value is not really large sum of money, it could be much less too – it has to fall under a particular category of transaction for it to go through LVTS – that is all). Banks do lend each other money. In a very simple term – to balance their books end of the day (at mid-night) banks either borrow the shortfall or lend the excess from/to each other. Bank of Canada monitors at what interest rate they are running the nightly show.

As of now the target rate is 1%. It means Canadian central bank will take deposit at 0.75% and lend at 1.25%. So, if X bank needs some money and Y bank it trying to lend at 2% then BoC will intervene and lend at 1.25% to X bank. Therefore it effectively maintains the very short term rate all over the market.

Since this is only a matter of one night – it is a very short term rate. This key interest rate also influences the variable rate market. Variable rates are anchored to bank prime rates and as of now the prime rate is 200 basis points above the key interest rate. 

For an average Canadian who prefers fixed rate this should not be an issue. Unfortunately our central bank indirectly promised to keep the rate at this level for a long time. Therefore the lenders are playing relatively longer term games based on this.

Buying funds on a short term basis and investing it on a long term plan (1 or 2 years mortgages) is providing the lenders a very efficient way of doing their businesses. This prolonged inaction also skewed the yield curves. That was indeed the intension of the government at the early stage of financial crisis but now it is hard for them to snap out of their own spell. The intension of the qualifying (now at 5.14%) rate was to partially handle this situation (by limiting the loan amount) but it did not gain much momentum.

Because of these reasons overnight rate is a matter of concern for fixed rate borrowers too. Any volatility in the key interest rate will have completely unknown effect on fixed rate mortgage. The central bank will not take any step in any direction that may cause trouble for common people because their mandate is to protect the interest of those. For now, according to some big Canadian lenders we will be good till end of next year.