Canadians received more proof yesterday of the global credit crunch hitting home after this country’s biggest banks began hiking their residential mortgage rates in an effort to recoup higher funding costs from their customers.

Banks are grappling with higher funding costs in the wake of last year’s subprime mortgage market meltdown in the United States. With the ensuing global credit crunch now in its second year, banks remain wary of lending to each other. The bond market has also been in flux ever since the United States announced a $700 billion (U.S.) bailout plan for American banks. Experts say the plan, while necessary, would likely stoke inflation. That, in turn, has made it more expensive for banks to finance residential mortgages.  The interest rates on mortgages and other short-term borrowing are set based on the price of bonds. With lower demand for bonds and fears of inflation, rates have to rise to lure investors.

It is also intersting to note that lenders are cutting back on their discounts on variable rates.  Some lenders no longer offer a discount to prime.  Once again, they are saying that this is due to investors increasing their costs and so the higher costs are merely being passed on to the consumer (whilst the banks will continue to make huge profits).  These developments should not, necessarily, scare borrowers who already have variable rate mortgages since they will have very attractive discounts to prime and their costs of borrowing are still very low.

These are indeed interesting times and we shall see how the financial turmoil unfolds in the coming weeks and months.

Source: Toronto Star

As expected, the Bank of Canada (BoC) left its overnight rate unchanged at 3%.

As per previous BoC announcements, there are three major global developments that continue to have a major influence on the Canadian economy (and therefore also interest rates):  The economic woes of the US and the persistent turbulence in global financial markets are mainly in line with what the BoC had expected.  It would appear that the third factor, higher commodity prices, could in fact decline due to slower demand for growth in global energy.  However, given tight inventories the expectation is that there could still be some volatility in commodity prices.  The reduction in commodity prices has been a significant factor in the decline of the Canadian dollar against the US dollar.  The slowdown in the Canadian economy has been higher than previously expected but still remains close to the economy’s production capacity.

On the inflationary front, global inflationary pressures still remain elevated.  In Canada, total CPI has climbed above 3% (due to higher food prices and energy costs) but core inflation (the main barometer that we are interested in) remains below the target of 1,50%.  The BoC continues to expect that total CPI will drop to 2% by mid 2009.

It would appear that the scene is set for a stable interest rate scenario in Canada, given the global economic slowdown, the continued world-wide credit crunch and the fact that inflation in Canada remains under control.

The BoC next meets on October 21, 2008.