As you probably read in any Canadian financial news source, the Bank of Canada decreased its prime lending rate by 0.25%. This was unexpected, but was explained as a move to stimulate the economy following a decrease in revenue from the oil and gas sector. How does this affect you? Read of for details...
Bond Yields
The most obvious immediate effect of this decision was on bond yields. New bonds issued by the Government of Canada today will have a lower yield. This means that previously-issued bonds with a higher yield suddenly became more valuable, and their prices increase. This effect trickles down into all government bonds. Because many corporate bonds are priced by the market at a certain premium to government bonds, their yield, too will decrease, and their price will increase. For example, the XBB ETF holding the universe of investable Canadian bonds is up over 3% since the beginning of the year.
The downside for the investor is that all fixed income yields have taken a hit. The yield-to-maturity of these medium-term bonds is now below 2%. This means that if you hold the bond fund for its duration, you should expect a roughly 1.5% return (after the management fees, but before taxes). This is likely to be below inflation.
Interest Rates
About a week after the Bank of Canada dropped its rate, the major Canadian banks dropped their prime lending rate by 0.15% [BMO, CIBC, RBC, Scotiabank, TD]. This affects any loans that are variable rate, such as lines of credit, or variable rate mortgages. Credit card debt, car loans, and fixed-rate mortgages are not affected because their rate is locked to a specific value for a certain term.
Those that have variable-rate mortgages saw an immediate benefit. Because the prime lending rate was dropped by less than the Bank of Canada rate, it's possible to get a greater discount from the prime rate. In many cases, it might be beneficial to pay a fine to exit your current mortgage agreement and negotiate a new one.
Feel free to contact us if you need help deciding how to reallocate your finances given the new interest rate environment.
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