The third quarter saw a stunning collapse in government bond yields as markets digested weak US economic data and an increasingly serious debt crisis in the Euro-zone. The yield on five-year Government of Canada debt fell an incredible 150 basis points from its peak in the first quarter to 1.35 per cent, the lowest level on record.
The current level of bond yields would normally prompt a dramatic fall in mortgage rates. However, there are a number of factors complicating the normal arithmetic. First, some lenders are offering deeper discounts for the most creditworthy borrowers. This allows banks to provide competitive rates while also filtering out higher-risk borrowers. Second, the short-term cost of funding for financial institutions worldwide, thereby squeezing profitability.
Moreover, the increasing popularity of variable rate mortgages due to very low rates may be putting further strain on the profitability of mortgage portfolios. Nearly a third of mortgages in 2011 are variable rate compared with 25 per cent five years ago and just ten per cent a decade ago.
Since variable rate mortgages tend to carry lower profit margins, the shift in consumer preferences to variable rate mortgages is likely cutting into profits. Shrinking profit margins have even prompted some banks to increase their offered variable rates in absence of a change in the reference prime rate.
Our forecast for the remainder of 2011 assumes that very low bond yields will persist through the end of the year and will therefore lead eventually to a cut in mortgage rates.
The five-year fixed rate has the potential to decline to its previous historical low of 5.19 per cent and will likely average around 5.3 per cent in the second half of 2011. The one-year rate is expected to average 3.5 per cent.
Given current economic weakness and the almost certain delay in any monetary tightening by the Bank of Canada until as late as mid-2012, both long-term and short-term rates will likely stay very low for most of 2012.
We expect that rates will move higher in the second half of next year, with the five-year rate hitting 5.6 per cent and the one-year rate reaching 4 per cent.
You can read BCREA’s full mortgage rate outlook at www.bcrea.bc.ca/economics.
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