July 6th, 2008

Bank of Canada Policy

Bankofcanada
The Bank of Canada has a 2% inflation target. That means they generally raise interest rates if
inflation rises materially above 2% and cut rates if inflation falls materially below 2%.

Since 1991 they’ve been pretty successful at meeting this mandate. Inflation since then has
averaged a mere 1.94%.

Now the BoC is reportedly thinking of tinkering with their 2% objective. Canadian Press reports they’re
now considering a 1.5% target after 2011.
If they made this change, one could argue that mortgage rates would stay lower long-term.  Although, many feel they’ll probably just stick with what’s working (i.e. 2%).

Even 2% might be a tough target to maintain, however. Economist Magazine predicts double-digit
inflation is around the corner for 2/3 of the world’s population. If that materializes, Canada won’t be unaffected. Many say the Bank of Canada will
likely have to brake inflation in 2009 by raising interest rates.

In reality, it’s impossible to say how rate policy will unfold in the next few quarters.  What can be said is that the Bank of Canada will soon be entering rough seas and it will be interesting to see how they steer our ship.

4 thoughts on “Bank of Canada Policy”

  1. As you’ve noted, the BoC has done a pretty fantastic job of meeting their policy targets over the past 17 years, which is why Canadians ought to have a great deal of confidence in their decisions.
    A lower target would be great for anyone with savings that aren’t indexed to the CPI, such as retirees. The negative aspect, of course, is that the Bank would need to induce higher interest rates, and people’s expectations have been set at 2% for so long that it could take a very long time for annual wage increases to start reflecting the lower target.
    IMHO they’ve got their plate full with more than a few problems at the moment, so I wouldn’t expect them to take this on.

  2. I think higher rates would be a short-term fix only if inflation flared up.
    Long term wouldn’t interest rates be lower with less inflation?

  3. I find this statement from the 2nd link quite interesting
    “Inflation benefits borrowers by allowing them to repay their debts with cheaper future dollars. For example, if you have a big mortgage to repay, then, as long as your wages keep pace with the cost of living, your debt will actually shrink.”
    Does this suggest that after inflation is over, people with mortgages before any inflation are better off? How true is this statment?

  4. Its true in a theoretical sort of sense.
    But if inflation hit, say 10%, you’d see mortgage interest at maybe 15% pretty quickly and what would that do to people renewing a 5 year fixed that was originally 5%?
    With that in mind, Ive always wondered why we Canadians cant have the same 30 year fixed mortgages they get in the States. Back when an American could get 4.9% on a 30 year fixed, a Canadian was stuck paying around 8.5% for a 25 year fixed, at the big banks anyway.

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