At long last, interest rates have gone up in Canada. This morning, Bank of Canada Governor Stephen Poloz announced a rate hike of 0.25 percent, bringing the interest rate to 0.75 percent.
Citing new data that has “bolstered the bank’s confidence in its outlook,” the bank decided to raise the rate for the first time since 2010.
The bank is pointing to a strong global economy, especially in the United States, coupled with a strong labour market and higher levels of direct investment here at home. While the bank isn’t exactly exuberant about the short-term trends for the Canadian economy — predicting that the “very strong” growth of the first quarter of the year will “moderate” over the rest of the year — it nevertheless points to strong household spending, a normalization of oil prices, and strong exports as good reasons to expect “above-potential” growth.
This is the first time interest rates have budged in more than two years. In July 2015, the Bank of Canada lowered interest rates from 0.75 percent to 0.5 percent, in response to the oil slump that had affected much of Alberta’s economy.
The Bank of Canada usually meets about eight times a year to assess the country’s economy and determine what policy tools should or should not be used to ensure things are running smoothly.
Low interest rates, in theory, are supposed to get people and companies spending. If the cost of borrowing is low, more people will access credit, more spending will occur to use that credit, thence stimulating the economy.
The next interest rate announcement is due on September 6, 2017 — many economists are predicting yet another slight bump in rates. They predict that the rate hike trend might continue well into mid-2018, if the Canadian economy continues to perform well.
If you’re a homeowner, start saving
The biggest (and possibly most troublesome) impact of an interest rate hike is the subsequent rise in mortgage rates. Let’s assume you have an outstanding mortgage of $400,000, and your current mortgage rate is 2.25 percent. This handy mortgage calculator tells me that your monthly mortgage payments are $1742.45.
Interest rates have now gone up from 0.5 percent to 0.75 percent. At the VERY minimum, the mortgage rate set by your bank, will go up 0.25 percent as well. At a rate of 2.5 percent, your monthly mortgage payments go up to $1791.85 per month.
That’s $50 extra, or three decent bottles of wine that you’ll have to give up every month.
Granted, that might not sound like a lot, but remember that firstly, banks will most likely raise mortgage rates more than 0.25 percent and secondly, considering that the average home price in a city like Toronto is almost $900,000, your mortgage is probably significantly more than $400,000.
If you don’t own a home, you missed out on the advantages of cheap credit
But there might be a silver lining.
The real estate boom taking place across Canada has been largely attributed to low interest rates. Sure, foreign speculation and population growth have been factors, but for the most part, Canadians are incentivized to buy a home because they end up paying so little in interest on their mortgages.
Economists are widely predicting a slowdown in the housing market, and to some extent the economy, if interest rates start to rise.
That’s no surprise — residential housing investment currently contributes to a hefty eight percent of our overall GDP. A recent note by Capital Economics predicts that GDP growth will slow from 2.4 percent in 2017, to 1.2 percent in 2018, sheerly due to the drop in home prices (and hence home sales).
Lower home prices are a great thing for all of you who have been biding your time, accumulating those pennies to dump on a home that used to be worth $900,000.
If you’re an avid traveller, you’ll soon embrace the Canadian dollar
This time back in 2014, the one Canadian dollar was worth 94 American cents. Fast forward three years, a loonie is only worth 77 American cents. The drop in the value of the Canadian dollar has indeed benefited out export sector (our good are more competitive on the world market), but it has screwed over travelling Canadians.
When interest rates go up, so does the loonie. This is only because higher interest rates attract foreign capital — investors get more bang for their buck by parking their money in a high-interest environment. The flow of foreign money into Canadian banks will increase the demand for Canadian currency, and hence the value of the Canadian dollar.
Of course, there are other mitigating factors like inflation and oil prices that can push the loonie down, but with higher interest rates, there’s a better chance that in the long run, one Canadian dollar will be worth more than it is right now.