Bank of Canada Raises Overnight Rate: Panic Ensues

Okay, maybe panic is the wrong word but after the Bank of Canada raised the overnight rate by 25 basis points, floods of headlines suggested this could spell trouble. “Central Bank Interest Hikes Begin to Squeeze Indebted Consumers“, read one headline from Post Media. Not just a “hike”, which connotes a dramatic increase, but the plural “hikes”, intimating there have been multiple dramatic increases.

Such is the life of a journalist and / or headline writer. We’re clearly not the first to observe that negative news sells (we’re even guilty of it ourselves with this headline!) but it’s a good reminder to look deeper into the topic.

First, why was there an increase? While a countless amount of variables are considered when adjusting the rate, Stephen Poloz and his band of merry cohorts weighed recent economic data and decided a raise was in order. Stats Canada just showed our economy expanded by a surprising 4.5% in the second quarter, which led all G7 countries.

Next question to ask: how will this rate affect borrowers? This is where some historical information helps frame this topic. Looking at the overnight rate over the past 30 years, the rates we had from 2015 until 2017 were very, very low.

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In fact, the Bank of Canada stated that “Governing Council judges that [this week’s increase] removes of some of the considerable monetary policy stimulus in place”. In other words, the rate was so low that the Bank of Canada considered it to be a flotation device for a floundering economy. Indeed, as our national economy felt the pangs of depressed oil prices in early 2015, the Bank of Canada lowered the rate to combat a potential recession. With recent data suggesting the economy is performing well (perhaps even over performing) it seems logical that the rate rises along side it.

Now make no mistake: it will cost more to finance a property, and those with variable rate mortgages will see an increase and those with mortgages coming up for renewal will also see higher rates. Indeed, individuals, companies and governments will see their costs of debt rise in the very near future. Alberta is still coming out of the most severe recession in decades so it will be interesting to see how these increases impact commercial real estate prices in Edmonton.

Notwithstanding how the low interest rates helped stimulate the economy, it’s imperative to note that rates cannot (and should not) stay low indefinitely. Not only does the Bank of Canada run low on options if another recession ensues (there’s not much room to lower it when it was at 0.5%), but low rates penalize the other side of the equation: savers. Those who save and invest struggle to earn a return that outpaces inflation, which may result in negative real rates of return.

Ultimately borrowers will see their borrowing expenses rise, but this should be prefaced with the fact that the overnight rate was lowered to unsustainable rates. Another way to look at it was borrowers had the chance to have lower interest expenses for couple of years and it’s now returning to reality.

As a closing metaphor, if a company is able to receive lower prices from a supplier, knowing full well that it will increase at some point, they would be prudent to plan for when it does return to normal. Don’t squander short term benefits, nor believe they will last forever.

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