Canada’s major economists exert a large influence on rate expectations in this country. So, it’s always interesting to hear an economist’s own take on the value of economic forecasting and rate projections.
For thoughts on this and more, we turned to Sal Guatieri. Sal has been forecasting the economy for over 15 years. Formerly with the Bank of Canada, he’s now Senior Economist at BMO Capital Markets. Sal is a frequent media commentator and an authority on North America’s economies, foreign exchange markets, and interest rates.
CMT: Sal, Thanks for being with us. Let me start off with a general question about economists. To what extent should mortgage shoppers rely on rate projections from major economists?
SG:Borrowers should use economic forecasts as a guide to shape their own view on where rates are going. You never want to take one forecaster’s outlook at face value. You want to take a consensus view and combine it with your own feeling of where things are going. It’s also the risks to the rate outlook that should guide your decision. Currently the Bank of Canada is moving very cautiously in raising rates given the sluggish U.S. recovery and uncertainty about Europe’s credit problems, so the risks to the rate outlook are likely on the downside.
CMT: And naturally, rate outlooks are just one part of the equation when picking the right mortgage term.
SG:Yes. Your mortgage decision depends critically on your own financial situation and how much risk you can tolerate. If you’re in a strong financial position with sufficient equity and a secure job, then you can readily absorb some rate increases, so a variable rate might be appropriate. If your budget is already fairly stressed at current interest rates then you probably would be wise to lock in—even though you don’t think rates will go up a lot in the next few years
CMT: How far out can economists project interest rates and still have a reasonable chance of being accurate?
SG:I could be facetious and say about 15 minutes. The longer you go out the more uncertain the forecast. A lot of times just getting the direction right is a chore. That’s not to say we don’t try to be right more than we’re wrong. But the truth is, being right just over 50% of the time is kind of a good thing. It’s something that you aim for.
CMT: Currently, where do your models forecast rates in the next few years?
SG:We think short term rates (those rates that are tied to the BoC overnight rate target) will go up about two percentage points by the end of 2011, and then a further one percentage point in 2012. The Bank of Canada will continue to raise rates very slowly. In total you’re probably looking at a three percentage point increase in short-term interest rates over the next few years.
CMT: Do you make forecasts beyond the next few years, or calls on long-term rates?
SG:We do have a longer-range forecast that goes out 3 to 5 years. It’s based on a view of where the economy is going and how policy makers will respond. In general, bond investors believe that current emergency-low short-term rates won’t last forever, and anticipate that long-term rates will need to rise over the next couple of years. We could see long-term rates go up approximately two percentage points in the next three years. But given the benign inflation outlook we don’t think long term rates will go up as much as short term rates. In fact, we think long rates could ease a bit further in the near term given fears of a double-dip U.S. recession.
CMT: Like you suggested before, the assumptions that go into these forecasts are always subject to change, right?
SG:That’s right. Most analysts—including the Bank of Canada—have recently revised down their outlook for economic growth. That’s due to the uncertain situation in Europe and slower growth in the United States. Given the uncertainty and volatility in equity markets, the outlook could change on a dime.
CMT: Rate forecasts often lead to discussions about fixed versus variable rates. Variable rates obviously have a better long-term track record than fixed rates. But given the possibility of higher rates in the next few years, how likely is it that now is one of the exceptions to that rule (i.e. that fixed rates will outperform variable rates)?
SG:The one problem with the historical track record that favours variable over fixed rates is that it generally covers a declining interest rate environment. Long-term rates have trended down and we haven’t seen dramatic spikes in short term rates as in the 1980s. It is very possible that the past may not be a good guide to the future. Just because variable rate mortgages won out in the last few decades doesn’t mean they will win out in the next 10 years. Interest rates could potentially trend higher in the next 10-year period, given that they are abnormally low today.
CMT: It’s obviously different for every borrower, but if you had to choose one rate today for most people, based on current projections, which would it be?
SG:It’s virtually a tossup between fixed and variable. If rates increase, even gradually as expected, then it would probably be preferable for most borrowers to lock in at a highly discounted 5-year fixed rate. But, the downside risks to the outlook suggest the variable rate may end up the wiser choice.
CMT: Thank you Sal.
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