Canada’s benchmark lending rate may rise further after central-bank Governor Mark Carney signaled yesterday the effect of three straight increases since June 1 is being offset by falling bond yields.
Carney raised the benchmark target rate for overnight loans between commercial banks to 1 percent from 0.75 percent yesterday, matching quarter-percentage point increases in June and July. Since the bank dropped a commitment to freeze the policy rate at a record 0.25 percent in April, yields on government 10-year bonds have dropped by almost 80 basis points.
Falling bond yields mean lower mortgage rates and cheaper consumer credit, even as the Bank of Canada removes stimulus from an economy that’s emerging from the worst financial crisis in two generations. The bank said in yesterday’s statement that while policy-rate increases mean Canadian financial conditions “have tightened modestly,” they are still ‘’exceptionally accommodative.”
“We’ve been debating in recent weeks whether the big decline in bond yields would actually make it more likely that the bank would hike interest rates -- because it basically offsets some of their tightening -- and it seems the answer is yes,” said Douglas Porter , deputy chief economist at Bank of Montreal’s BMO Capital Markets unit in Toronto.
Traders reacted to the central bank’s statement by dumping government bonds, driving up two-year yields by the most in two months. Yields on December bankers’ acceptances, the most active contract, surged 16 basis points, or 0.16 percentage point, the most since April, as traders increased bets on boosts in the overnight rate.
Falling Mortgage Rates
The rate for conventional five-year mortgages, the most popular in Canada, was 5.39 percent Sept. 1, down from 6.25 percent in April, according to Bank of Canada data. That’s near the 5.25 percent rate in March and at the end of May 2009, which was the lowest since the Bank of Canada data begins in 1973.
Elsewhere in credit markets, the extra yield investors demand to own Canadian corporate bonds rather than federal debt narrowed to 148 basis points yesterday, from 149 basis points the day before, according to a Bank of America Merrill Lynch index. Spreads have been as wide as 154 basis points and as narrow as 114 basis points this year. Yields rose to 3.80 percent yesterday, from 3.71 percent the day before. Corporate bonds have lost investors 0.8 percent so far this month.
Quebec, Canada’s second-most populous province, sold C$500 million ($482 million) in a reoffering of its 5 percent bonds due in December 2041, bringing the total outstanding to C$4.5 billion. The debt priced to yield 94.5 basis points over government benchmarks.
Ontario, Canada’s most populous province, sold $1.25 billion of five-year notes denominated in U.S. dollars, according to data compiled by Bloomberg. The 1.875 percent notes yield 44.7 basis points more than similar-maturity Treasuries, Bloomberg data show.
Provincial bonds’ relative yields held steady yesterday at 57 basis points. Spreads have been as wide as 71 basis points this year, and as narrow as 39.
Bell Aliant Regional Communications, based in Halifax, Nova Scotia, plans to sell C$350 million of 4.37 percent notes due in September 2017, the telephone provider that serves rural areas said in a statement yesterday.
Toronto-Dominion Bank, Canada’s second-largest lender, is increasing its prime lending rate by 25 basis points to 3 percent, effective today, in the wake of the Bank of Canada announcement, according to a statement. All other major Canadian banks followed suit.
Canada was first among Group of Seven countries to raise borrowing costs after last year’s global recession. It has recovered from the slump faster than the U.S., having already returned to pre-recession levels of employment.
“Going forward, consumption growth is expected to remain solid and business investment to rise strongly,” yesterday’s Bank of Canada statement said. “Both are being supported by accommodative credit conditions, which have eased in recent weeks mainly owing to sharp declines in global bond yields.”
“As bond yields have come down, mortgages have come down,” Carlos Leitao, chief economist at Laurentian Bank Securities in Montreal, said in a telephone interview. “That has perhaps offset some of that tightening” from the central bank, he said.
The statement may have “disappointed” some investors, who were expecting the bank to signal a pause in rate increases for the rest of the year, on signs of a slowing U.S. recovery, Leitao said.
“In one sense, the Bank of Canada has been running hard on policy to stand still,” Stewart Hall, an economist at HSBC Holdings Plc’s HSBC Securities unit in Toronto, wrote in a note to clients.
Yields on two-year notes rose 13 basis points yesterday, the most on a closing basis since July 8, to 1.42 percent. Two- year yields reached an 18-month high of 2.07 percent in April, before the European debt crisis sparked a rush to the perceived safety of the bonds of governments with relatively strong balance sheets. Ten-year yields climbed 11 basis points yesterday, the most since May 27.
Canada’s long-term foreign- and local-currency issuer default ratings were affirmed at AAA yesterday by Fitch Ratings, which cited the country’s “comparably stronger economic and fiscal performance during the global financial crisis.” The outlook is stable, Fitch said.