On Wednesday, July 15th, the Bank of Canada will announce whether they will maintain the overnight rate at 0.75% or whether they will cut it for the second time this year. The likelihood that they will announce a rate cut has risen, but the current economic environment means that it is unlikely to affect you very much. This article explains why.

If the Bank of Canada were to cut their overnight target rate on Wednesday, or later in the year for that matter, it is unlikely to have a sizable affect for several reasons:

• This Bank of Canada has much more influence on short-term interest rates. The mechanisms of the private market are the primary drivers of change in the 5-year government bond yields. It is these yields that drive fixed mortgage rates, not the overnight rate. This is evident in the chart above, which shows declining overnight rates, juxtaposed with steady mortgage and bond yields through 2009 and 2010. So while short-term interest rates might fall, longer-term interest rates will be less affected;
• You probably don’t have a variable rate mortgage anyway. Three quarters of mortgages are generally fixed rate mortgages. A fall in the overnight rate would lower the prime rate set by banks. This would then lower the interest rate on variable rate mortgage products, as well as a number of other interest rates that are directly tied to the prime rate. However, as we said, that probably doesn’t affect you anyway.
• Banks did not fully match the last rate cut and probably won’t next time. When the Bank of Canada last cut the overnight target rate by 25 basis points, banks responded by lowering their prime rate by just 15 (with a lag). With household debt still a major concern among policy-makers, don’t expect any political pressure for banks to match the next cut.

How an Interest Rate Cut Could Benefit You

• As we mentioned earlier, most homeowners continue to choose a fixed-rate mortgage. Furthermore, unless you are up for renewal or you are buying a home, a shift in the fixed-rate won’t affect you anwyay;
• If, however, you currently have a variable rate mortgage, or a line-of-credit that is tied to the prime rate, you would see you interest rates fall if the Bank of Canada reduced their overnight rate target.

Why an Interest Rate Cut is More Likely

Simply put, a number of economic data have come out on the depressing side as of late:

• Statistics Canada recently reported that capital expenditures intentions for 2015 are down by 5%, led by a roughly 20% decline in the oil & gas industry. That is a lot less spending, which will impact jobs. The Bank of Canada might act to stimulate investment by lowering borrowing costs and the return on safer investments;
• We might be in a recession. We have now tallied four straight months of declining GDP. If that trend continues, we will officially be in a recession. Forest fires in Saskatchewan and Alberta only make this outcome more likely;
• As you might imagine, the economy is growing much more slowly than the Bank of Canada last forecast. As such, the current interest rate target is up for revision.

On the Other Hand

One might argue that the efficacy of a rate-cut is somewhat reduced. Businesses still have easy access to capital and punitive interest rates aren’t exactly the thing holding them back right now. It is just as likely to contribute to rising household debt, something policy-makers are keen to avoid. With minimal benefits to the business sector, it is possible that the BoC will hold tight. As of Monday, markets are pricing in a 50% chance of a rate cut.

Perhaps it is time for fiscal intervention, rather than monetary stimulus? With the upcoming election and all of the focus on balanced budgets, however, that seems unlikely in the near-term.