May 28, 2010, 6:38 am

Looking Forward: The Bank of Canada Prime Rate Decision on June 1st 2010

by: The Financial Blogger    Category: Banks and You
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Next Tuesday, The Bank of Canada will announce the new (or unchanged!) Prime Rate. For several months now (since the credit crunch of 2008), The Bank of Canada has maintained its prime rate at the virtually lowest level possible; 0.25%.

We started to read about potential rate increase in late 2009 when Australia had increased its rate several months in a row. However, the Australian reality appears to be quite far from that of the Canadian economy.

Controlling Inflation

The most important reason why the Bank of Canada would increase their interest rate would be to maintain the inflation at an “acceptable” level. This level is currently set between 1% and 3% with a “ideal” rate of 2%.

Since we have been flirting with the 2% inflation rate for a while (currently at 1.9% as of April 2010), many economists have predicted that the Bank of Canada would start increasing its interest rate as previously mentioned by Mark Carney, Governor of The Bank of Canada.

There are more clouds in the sky than expected

The Bank of Canada was ready to stop the low interest rate party this summer but recent events in Europe might cause the Bank reconsider its strategy. Considering the economic problems stemming from the PIGS (Portugal, Ireland, Greece and Spain), the stock market has responded negatively.

Therefore, the economy may slow down again and reduce the inflation risk. Considering this scenario, there is no urge to increase the prime rate right away.

The general demand for resources is slowing down as the price of oil has dropped significantly. This will also have an important effect on inflation (even though they consider the inflation rate with and without the price of oil).

What is my bet on the Canadian Prime Rate?

I bet it will increase by 0.25% but I would definitely not be surprised if it stays at 0.25% until July. The only point I am quite confident of is that we won’t see an increase of 0.50% or 0.75% as some economists were predicting a few months ago.

It’s not that they were wrong in the predictions; it is just that today’s economy evolves so fast that your 5 year projection are probably right when you do them but they go wrong 2 weeks later ;-).

I hope to benefit from low interest rates till the end of 2010. This would help me stabilize my finances after my moving in June. This fall, I will seriously attack my mortgage so it starts decreasing faster than it has been for the past 2 years!

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I also expect a 0.25% increase in June. The Canadian economy has been strong in general.

Curious why paying down you mortgage faster is a goal with interest rates so low right now? I’ve learned a lot from you blog just trying to understand the reasoning better.

by: The Financial Blogger | May 28th, 2010 (10:52 am)

@ Ticker,

I actually want to create a loose on my line of credit. It is much easier to pay it off quickly when the rates are super low.

Since I have been leveraging a lot these days with my company, I want to drop my mortgage by about 10K. I like to have liquidity available 😉

On the other side, I am also looking to start a new Smith Manoeuvre (levareging against my HELOC) during summer time. I’ll try to invest about $500 per month and keep focusing on paying down the rest of my HELOC as fast as I can.

I used to look at interest rates and think that I can beat it and just invest the extra money instead. The big difference with a mortgage over an investment is the way lenders calculate interest on the load. You pay so much interest early and very little in the end. If you are early in your mortgage, it’s much more beneficial to accelerate your payment than if you have 5 years left or so. The reason is that all you pay in the early years is pretty much interest. If you pay it faster, the principal go down and the compounding factor in mortgage interest calculation provides a significant reduction. That’s why paying your mortgage every 2 weeks significantly reduces your amortization at the beginning. You can go from 25 years to 21.6 years just by making 2 extra payment in a year (1 more per 6 month and interest is calculated every 6 months usually).

In short, the mortgage interest percentage doesn’t come close to compare apple to apple with an investment unless your investment is a gold mine and you can keep it up.

+0.25%, my bet. I think we are more influenced by BRIC than PIIGS, anyway Canadian economy is doing quite well, the real estate market has been flourishing for several months and BoC removed its commitment recently. Not much, but it will go up.

Thanks for the responses, makes a lot of sense.

Good bet 😉 Will the Bank of Canada increase rates again in July?? What do you think??

[…] was just reminded again recently when commenting on a post at The Financial Blogger at how investors with a mortgage struggle with the decision of investing or paying off your […]