When Will Prime Go Up, And Does It Matter?

If you’re concerned about prime rate rising, you don’t have to worry about inflation—for now anyway. 

Headline inflation recently posted its biggest annual drop since 1950, down 1.3%.  As for core inflation (which excludes volatile food and energy prices), it rose an acceptable 2% in the last 12 months.

So, with inflation foreseeably in check, what else could push up prime?  Well, fortune tellers we are not, but the following can be said for sure.  Bond traders will know before we do.

The bond market is where people bet billions of dollars on interest rate movements.  It’s a fascinating market to watch.  The two-year bond yield can be especially telling.  Over time, it’s demonstrated a tendency to lead prime rate.  Here’s a chart that illustrates that effect.

2yr-vs-Prime
The 2-year yield typically rises 3/4% to 1% before prime increases, and it usually does so at least a few months in advance.  The exceptions occur when the Bank of Canada makes surprise rate hikes.  In these cases, multiple prime-rate increases often follow.

This is all great, but here’s the thing.  None of this is probably relevant to your mortgage.  That’s because there are problems with using the 2-year bond as a leading indicator:

1)  It’s not foolproof.  While it may only happen in a minority of cases, there will be headfakes (times when the 2-year rises and prime doesn’t follow). Bond expert, Hank Cunningham, also suggests that the 2-year bond may have less “predictive ability” until the BoC’s current “emergency rate policy” is over.

2)  Knowing when prime will rise may not help you.

Let’s examine that last point. 

Suppose you were timing when to lock in and you knew with certainty that prime rate would rise in six months.  Would that save you money?  Yes, you say.  It would tell me when I’d need to lock in.

Okay, but what if fixed rates are notably higher in six months?  In that case, you’d be worse off by sitting in a variable-rate mortgage and waiting to lock in. 

If you’re timing when to lock in a variable-rate mortgage, not only do you need to predict prime rate, you need to accurately predict fixed rates as well.  Unfortunately, your chances of being right about both are only 25% (based on random probability).

You’re better off basing your decisions on things you can reasonably foresee.  That includes things like your job stability, savings rate, anticipated debts, home equity, your sensitivity to rate changes, historical interest rate relationships, etc.  These are the main factors a mortgage professional will assess when advising between fixed or variable rates. 

For most people, their odds of success are better if they don’t try to outguess the rate market.  Their chances improve even further if they don’t go it alone.  Getting professional advice from a licensed mortgage planner increases one’s chances of success regardless of where rates go.

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