Interest Rates Nudge Higher
The Bank of Canada raised its key lending rate one-quarter of a percentage point to 0.75% from 0.50%. This represents the first rate hike since 2010. The big question is, is this good or bad news for Canadian investors?1
The Bank of Canada initially lowered its interest rate to prevent the Canadian economy from experiencing the same kind of economic nightmare that sent the U.S. into the Great Recession.
Artificially low interest rates make it cheap to borrow money. Businesses and people that borrow more are more likely to spend, and this is supposed to help kick-start the economy. By raising the overnight lending rate to 0.75%, the Bank of Canada is essentially saying the Canadian economy is on solid ground and can support the modest rate hike. In fact, many expect the Bank of Canada to raise its rates again in October.
The overnight lending rate is what major banks and financial institutions charge each other on one-day loans. Rising rates mean is costs more now to borrow money than it did before the hike. But banks are banks so they’re going to pass that rate hike along to customers.
How will the rate hike affect Canadians and the stock market?
Stock Market Investors
Rising interest rates are generally good for the stock market because it means the economy is improving. That suggests that corporate earnings will also rise.
Keep in mind, even though the Canadian economy is improving and is, according to the Bank of Canada, to grow above potential, the Canadian stock market is actually among the worst performing markets in 2017.
But not all stocks are going to benefit from the rate hike and some sectors will do much better than others. After all, the rate hike will hit consumer spending, borrowing costs, and could undermine earnings of those companies that rely heavily on exports.
Canadian Dollar
Following the announced rate hike, the Canadian dollar soared to its highest level in more than a year against the U.S. dollar. Key bond yields also rallied in anticipation of another rate hike this fall.
But again, there are concerns that a higher dollar will negatively impact consumer spending, raise borrowing costs, and hurt corporate profits of export-heavy stocks.
Canadians in Debt
Canadians are carrying a record amount of debt. Debt tied to interest rates like lines of credit, credit card rates, and car loans are going up. Most home equity lines of credit have variable interest rates. The recent rate hike was small, but a series of rate hikes could make it difficult for some Canadians to make ends meet. If you have a variable-rate credit card, it’s going to cost more to carry that debt.
Canadian Home Owners
Shortly after raising its key lending rate, Canada’s big banks announced they were increasing their prime rates, that is, the rate they use to set variable rate mortgages, lines of credits, and other loans.
Homeowners that have a fixed mortgage will not feel the rate hike right now. That’s because the mortgage is fixed. Nothing will change until the mortgage comes up for renewal. The rate hike will have an immediate impact on those with variable mortgages.
Those looking to buy a home will notice fixed mortgage rates have increased slightly. And will rise again if the Bank of Canada raises rates again this fall.
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Rising interest rates are supposed to be a good sign for the Canadian economy. But rate hikes can also be a mixed bag for investors. Some sectors will perform better than others and some commodities actually do poorly when economic projections are strong.
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Sources:
- “Bank of Canada increases overnight rate target to 3/4 per cent,” Bank of Canada, July 12, 2017; https://www.bankofcanada.ca/2017/07/fad-press-release-2017-07-12/.
