COVID 19 – BoC Makes Emergency Rate Cut and Delays Stress Test Changes

Wednesday Aug 12th, 2020

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The Bank of Canada (BoC) has declared a reduction in the emergency rate to its trend-setting overnight lending as the Canadian government seeks emergency actions in light of the novel Coronavirus pandemic.

The central bank announced in an unscheduled announcement on March 13 that it was cutting its interest rate to 0.75 percent – the second 50-base-point cut this month. BoC Governor Stephen Poloz said it was a "proactive move," as the Canadian economy is coping with the virus' effects, along with the social distancing steps that are already in place to avoid its spread. Also, recently falling oil prices have led to the decision to cut borrowing costs.

"It's obvious that coronavirus transmission has significant consequences for Canadian families and the economy of Canada," the BoC said in a statement. "Additionally, lower oil prices will weigh heavily on the economy, especially in energy-intensive regions, even after our last scheduled rate decision on March 4."

The BoC is expected to issue its next rate decision on April 15, along with a complete update on its monetary policy plans.

An Out-of-the-Ordinary Move

Announcing a rise in interest rates outside of its regular six-week schedule is particularly irregular for the BoC; the last time it did so was during the financial crisis in 2009. Combined with the March 4 interest rate cut, the overnight loan rate now stands at 0.75%.The statement was made in conjunction with statements from Federal Finance Minister Bill Morneau and Financial Institutions Superintendent Jeremy Rudin that financial assistance will be announced in the coming weeks in support of Canadians soon.

The move had been replicated by the United States. The Federal Reserve, which decided to lower its interest rate range to 0 percent on March 15, also this month in its second rate cut.

Why is the Bank of Canada Cutting Interest Rates?

One of the BoC's critical tasks is to support the Canadian dollar alongside the inflation rate. Among the most effective tools to do so is the ability to change the borrowing costs through its Overnight Lending Rate, which consumer lenders use as a proxy for each other's borrowing costs, thereby holding funds liquid.

They often use the BoC's rate when determining the cost of their own variable loan rates. If the BoC makes a move, the "Big Five" – think Montreal Bank, Scotia bank, TD, CIBC, RBC – usually follow suit with cuts or changes in the cost of their variable mortgage and credit line.

The BoC can help prevent a credit crisis by keeping borrowing rates low for mortgage borrowers in an economic downturn; surplus reserves between banks mean they can afford to lend to customers, which in turn keeps household spending and demand going.

New Stress Changes to be Delayed

Together with the rate cut and stimulus pledge, it was also announced Friday that it would be placed on ice until further notice previously promised improvements to the mortgage stress check, which was expected to take effect on April 6.

On February 18, the Department of Finance announced that it would change the qualification requirements used in the insured mortgage lenders check by moving from the five-year benchmark rate of the Bank of Canada (which in turn is set by an average of five-year fixed rates reported by the Big Bank) to the weekly five-year median insured mortgage rate used in mortgage applications, plus 2%.

The reform would have significantly lowered the threshold that such borrowers need to apply for home financing, as the rates provided by lenders for insured mortgages are usually much lower than the rates posted by big banks; for example, the current BoC rate is 5.19%, whereas many lenders currently offer insured mortgage rates below 3%. In fact, if the new median price was made available now, it would be at 4.89%.

According to Ratehub.ca estimates, a borrower with a household income of $100,000 earning a mortgage rate of 2.89 percent and being assessed at the new rate will qualify for a home priced at $526,632, $15,000 more than the $511,424 they will receive at the present rate.

Although the move was just for mortgage lenders putting their home purchase down less than 20 percent, it was generally anticipated that the same adjustment would also be made for the uninsured mortgage market. However, the Office of the Superintendent of Financial Institutions (OSFI) also announced that the consultations it was preparing to conduct would be postponed, meaning that simpler stress testing conditions would not be seen for any form of borrower soon.

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