It’s the second time this year that the Bank of Canada had dropped the rate to stimulate the economy.
The 25-basis-point drop to 0.5 per cent on Wednesday was also anticipated by many forecasters given the state of the economy.
The economy has contracted by 0.6 per cent from January to March and by 0.5 per cent between April and June.
What does that mean?
Technically we are in a recession when the economy has suffered two consecutive negative quarters.
A day before Bank of Canada governor Stephen Poloz was to announce the rate cut, Phil Soper, chief executive of Royal LePage urged the Bank of Canada to reconsider the move. “We believe an additional interest rate cut, which has been discussed with increasing frequency in recent weeks, would be inappropriate policy at this time,” he said.
Royal LePage, the big player in the real estate business is worried about the impact another rate cut will have on the country’s sizzling housing market.
“I worry that stoking this engine further could move us from a perfectly manageable major market expansion into a more difficult correction, as price levels decouple from more household incomes,” Soper said in the report.
The impact could be immediate for anybody with a mortgage tied to the prime lending rate, now at 2.85 per cent, which traditionally tracks the Bank of Canada rate but not always.
The immediate fear is that the latest interest rate cut will encourage those barely in a position to make their mortgage payments to enter the market and buy over-valued homes, the increased demand will push the price of a home up even further. The danger is when interest rates start to rise in the next couple of years, house prices will fall sharply, depending on the economy. This could send speculative investors and those in a precarious financial situation into a panic, leading to the long predicted serious correction in the housing market. This could have a cascading effect on the economy which would slide into a very serious recession.
“Overvaluation remains a concern,” said Stephen Poloz but added that “the probability that a sharp correction in house prices will occur remains low.”
So is Stephen Poloz underestimating the danger? Many critics seem to think so. Low oil prices have ravaged the economy in Alberta which in May was responsible for all of the country’s net employment growth over the past 12 months, adding 81,800 jobs while the rest of Canada lost 9,500. The Iranian nuclear deal will see oil from that country flooding the market which will add to Canada’s economic woes in the months to come.
One of the fallouts of low interest rates is the effect it has on savers with diversified portfolios. Conventional wisdom suggests savings are the prime source of real long-term investment, but today’s low interest rates are not yielding much compared to real estate, so many Canadians are parking most of their wealth into a single home or an investment property.
Typically low interest rates spur people on to take on larger and riskier debt. Homebuyers believe they should buy as much housing as they can afford not necessarily as much as they need.
All bets are currently stacked on real estate being the best investment one could possibly make, one that will continue to make investors fabulous profits. This sort of thinking is why realtors are laughing all the way to the bank, which is why the warning bell sounded by none other than LePage this week was most unusual and sobering at the same time.