The global economy is feeling the lasting effects of the most serious financial crisis since the 1930s. As meticulously documented by economists Ken Rogoff and Carmen Reinhardt in their examination of eight centuries of data, recoveries from financial crises are characterized by sluggish growth in output and employment.

Although Canada’s relatively stodgy banking system ensured that we did not suffer a domestic financial crisis, our fundamental dependence on the United States, the epicenter of the global crisis, means that we are mired in the second-hand effects of the US’s economic lethargy.

However, as we detail below, there may be a silver lining for BC households in these cloudy skies.

Second quarter GDP growth fell well below expectations at just 2% (annualized). This represented a marked deceleration from first quarter growth of 5.8%. Flagging consumer spending and weaker residential investment resulting from the expiration of the home renovation tax credit tempered growth in the second quarter.

Economic growth in the remainder of 2010 and 2011 may continue to underwhelm due a cooling housing sector, sluggish economic growth in the United States and an end to Government fiscal stimulus. Moreover, unemployment that is projected to hover near 8% for several quarters may hinder consumption going forward.

In all, we see the Canadian economy growing at a 3.3% pace in 2010 before slowing to 2.5% in 2011.

In the face of slowing growth and low inflation, the Bank of Canada raised rates for what we expect to be the final time in 2010 at its September 8 meeting. Although the Bank’s medium-run objective of returning rates to normal longrun levels is still intact, the Bank will take a very cautious approach to tightening monetary policy over the next 6 to 12 months and further rate tightening will be highly dependent on how solid the ground is underneath both the Canadian and US economies.

Given that inflation is projected to remain subdued and growth is expected to slow, we have trimmed our forecast for the overnight rate to 1% at the end of 2010 and 2 % by the end of 2011 (from 1 %- 1.25 and 2.5 % respectively).

In our July forecast, we noted that mortgage rates would continue to trend lower in the short-run and indeed downward pressure on interest rates has not only continued, but has in fact intensified.

Although fear stemming from the European debt crisis has seemingly subsided, fresh concern has emerged about the United States’ economy where hopes of a “summer of recovery” have quickly faded into fear of a dreaded “doubledip” recession.

In response, cautious households and companies have increased savings, adding to the flood of demand for safe assets and forcing long-term Government bond yields to levels not seen since the height of the global financial crisis.

Yields on Canadian Government 5-year bonds, the benchmark for mortgage pricing, have fallen a remarkable 100 basis points since the spring to just 2.1 %. Although this decline in interest rates is likely overdone, it is difficult to say when bond markets may normalize.

A much discussed second round of quantitative easing by the Federal Reserve (so-called QE2) could mean that US and Canadian interest rates stay low for an extended period. On the other hand, unexpected good news on the US economy may translate to faster pace of interest rate normalization.

The silver-lining in the lacklustre economic outlook is that the normalization of both short-term and long-term interest rates will be deferred. BC households with variable rate mortgages will therefore be facing lower payments than we would have originally predicted at the beginning of the year.

Moreover, new homebuyers or homeowners set to renew their mortgages will be offered a second chance at securing rates at levels last seen at the depths of the financial crisis.

The BCREA mortgage rate forecast is for a continuation of the current low-rate environment into early 2011, when prompted by a new round of tightening by the Bank of Canada and (hopefully) brighter economic prospects, interest rates will renew their ascendency to historical norms but at a measured pace.

The 1-year fixed mortgage rate is forecasted to finish 2010 at around 3.2 % and to reach 4.05% by the end of 2011. The 5-year fixed mortgage rate is forecasted to end the year at 5.35% and to reach 6.1 % by the end of 2011.