Deciphering the prime lending rate announcement

Last week the Bank of Canada surprised everyone by lowering the prime lending rate. They dropped the prime lending rate by .25% to .75%. The media have been all over this but what does it actually mean? Let’s break it down a bit into an informative little article written for the average consumer who does not have a degree in economics.

Why?

The first reason the Bank of Canada cited for this change is the sharp decline to the price of oil. Here in Alberta we are well aware that this has been happening. The lower price of oil is expected to boost global economic growth especially in the U.S.

The falling Canadian dollar will help to boost non-energy based industries as we see an increased demand for those products from foreign economies.

Another reason cited is that inflation has remained close to the 2% target in recent quarters. The weaker oil prices will pull down the inflation profile.

So basically the Bank of Canada is reacting to the oil price shock and is attempting to provide some insurance against the risks to the entire economy going forward.

What now?

So the announcement was followed by the gleeful hoorays of those who opted for a variable rate mortgage.

A variable rate is where the interest rate is based on the prime rate less an ongoing discount or plus an ongoing premium. For example, if you opted for a variable rate mortgage recently your rate is likely around prime, which is currently 3%, less .6% or 2.40%.

The Bank of Canada sets their prime lending rate and the banks’ prime lending rate is at 2% higher.

Most people thought that the recent announcement would see their rate fall by the .25% to match the Bank of Canada decrease but that has not been the case. At the time I am writing this article, none of the big five banks have opted to decrease their prime lending rate as of yet.

They are not mandated to do so though it is likely that if one of them does they all will and that the decreases would happen within hours of each other.

Let’s remember that banks are a business with shareholders and investors and the goal is to produce a strong profit each year. Profit is not a dirty word and considering that our banking system is the envy of many it is a very good thing they are run the way they are.

Remember the international economic troubles in 2006-2009?

Our strong banking system is cited as one of the reasons we made it through far easier than other countries. So all that being said, the banks may be working towards strengthening the bottom line which may mean no rate drops in the near future.

You may also be affected by this if you opted for a loan or a line of credit based on the prime rate plus or minus whatever discount you negotiated.

The Bank of Canada is scheduled for its next announcement on March 4th. Economists are forecasting an additional decrease by the Bank of Canada but we will just have to wait and see.

Pam Pikkert is a mortgage broker with Dominion Lending Centres – Regional Mortgage Group in Red Deer.

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