Wednesday, April 22, 2009

Consumers in a position to spend should get a quick boost from the Bank of Canada's record-setting interest-rate cut Tuesday as commercial banks respond with corresponding reductions in some of their important rates.

Canada's major banks answered the central bank's 0.25-percentage-point cut in its key overnight lending rate with a similar reduction in the prime interest rate they charge their best customers, lowering it to 2.25 per cent.

That brought the banks' variable mortgage rates, which are tied to movements in the prime rate, down as well, giving existing mortgage holders a break and potentially more cash in their pockets.

The move also helps qualify more first-time buyers as the lower rates put mortgages into closer reach of lower incomes."This is a good thing for the home-buying market," John Turner, director of mortgages for BMO Financial Group, said in a conference call.

For example, Turner said, the prime-rate cut brought the rate on BMO's five-year variable-rate mortgage to 3.05 per cent from 3.3 per cent, which would reduce payments on a $200,000 mortgage by $26 a month.

While it doesn't sound like a lot, Turner said the reduction of rates "brings more consumers into the market who likely may not have qualified before."

Banks have flipped the relationship between their variable-rate mortgages and the prime lending rate as the Bank of Canada has slowly brought down its key overnight rate, the rate that it charges banks for short terms.

Where banks used to offer discounts to the rate, which were in the range of 0.75--0.85 of a percentage point a year ago, they now charge a premium of a similar amount on new mortgages.

Consumers who hold those existing, prime-discounted mortgage rates are seeing a boost to their spending power, Karl Madsen, B.C. regional manager for the mortgage broker Invis, said in an interview.

"If you [hold a mortgage] at prime minus [0.75 of a percentage point], your rate is at 1.5 per cent," Madsen said. "Think of that in terms of how that affects the economy."

Borrowers who opt to keep their payments at the same level will pay down their mortgages more quickly.

Those who opt to adjust their payments to account for their loans' lower interest have more money to spend, "which is good. We're trying to spur the economy, and that extra spending money available will do that."

Derek Holt, vice-president at Scotia Economics, said the Bank of Canada's statement that it expects to keep its overnight rate at its current low until at least the middle of next year was just as important a step for consumer spending.

"Saying that rates will be low for a long time, that impacts the whole short end of the bond-yield curve," Holt said, "and that should lead [to lower rates] even for two to three-year revolving and non-revolving consumer loans."

On the savings side, however, the cut in rates will likely also mean lower interest rates paid on savings accounts.

Scotiabank on Tuesday reduced the interest rate on its high-interest Power Savings account to 1.25 per cent from 1.5 per cent, and the rate on its Money Master to 0.5 per cent from 0.6 per cent.

"There are a bunch of offsetting influences on savings rates," Holt said.

Consumers worried about their jobs, or who have lost money on investments, might want to save more money, Holt said. The low interest rates, however, don't give much incentive to save a lot of money.

"In terms of the short-term cycle, rates are designed to discourage too much of a personal savings rate and ensuring you get enough spending [throughout the economy]," Holt said.