Bank of Canada Maintains Prime , Hints at Future Increases

The Bank of Canada yesterday maintained it’s key overnight lending rate at 1%, holding the Prime rate on which Variable rate mortgages are based at 3%.

In their press release, they listed several factors being considered in the decision….

“Overall, economic momentum in Canada is slightly firmer than the Bank had expected in January.”
“…The economy is now expected to return to full capacity in the first half of 2013.”
“…The profile for inflation is expected to be somewhat firmer than anticipated.”
“Europe is expected to emerge slowly from recession in the second half of 2012”

Finally, the note hinted at future possible rate increases in the form of “Stimulus withdrawal”….

“Reflecting all of these factors, the Bank has decided to maintain the target for the overnight rate at 1 per cent. In light of the reduced slack in the economy and firmer underlying inflation, some modest withdrawal of the present considerable monetary policy stimulus may become appropriate, consistent with achieving the 2 per cent inflation target over the medium term. The timing and degree of any such withdrawal will be weighed carefully against domestic and global economic developments.”

The potential withdrawal of stimulus may force a reaction on the bond market, driving up bond yields that in turn reflect in fixed mortgage rates.    The fundamentals of the relationship between bond yields and fixed mortgage rates (typically a 1.25% difference between the 5 year Bond  yield and 5 year fixed rate mortgage) don’t support this, since bond yields are still much lower then fixed rate mortgage imply given their historical relationship, but only time will tell.