Low Interest Rates Help Kick-Start Economy
Many foreign governments have pointed to the Canadian economy as a well-run machine that avoided the economic turmoil that plunged the U.S., the eurozone, and much of the Western world into a recession in late 2007.
Canada still slipped into a recession in 2009, but not for very long. In fact, to help kick-start the Canadian economy, the Bank of Canada artificially lowered its overnight lending rate to 0.25% in April 2009.
Lowering interest rates is supposed to help stimulate the economy because it makes it cheaper for businesses and people to borrow from the banks. In late 2010, the Canadian economy showed signs of improving and the central bank raised its lending rate to one percent.
While lowering interest rates helped Canada avoid the Great Recession, the Canadian economy did not rebound as quickly as hoped. As a result, the Bank of Canada pegged the key interest rate at one percent for 51 months, from September 2010 until December 2014.
Canadian Economic Growth Muted
The central bank hinted it wouldn’t raise rates until the Canadian economy was on sustainable footing; it’s still waiting. Slumping oil prices, stagnant wages, and slower economic growth forced the Bank of Canada to make an unexpected cut to its lending rate in January to 0.75%.
On March 4, the central bank announced it was keeping its rate at 0.75%, saying no further cuts or increases were necessary. The bank is essentially taking a wait-and-see approach to observe how the economy responds before moving the rate again.
But the fact of the matter is that the Canadian economy remains fragile and there is a good chance interest rates won’t rise until late 2015 or even 2016. In addition, any future increases will remain small, meaning that interest rates will hover near historic lows for the unforeseeable future.
Interest Rates Need to Stay Low
Aside from low oil prices hindering the economy in Alberta and Saskatchewan, one reason why the bank can’t raise interest rates is because it can’t afford to. In January, Canadian household debt grew 4.6%, the fastest pace in the last two years.
Canadians took on an additional $80.0 billion worth of mortgages, personal loans, and credit card debt in the past year, much of it following the bank’s lowering of its rate to 0.75%.
In January, Canadian household debt totalled $1.82 trillion; the country’s GDP stands at an annualized rate of $1.65 trillion, meaning we owe more than we make. But thanks to low interest rates, Canadian automakers had their second-best February for sales on record.
Specifically, Canadians are in debt to the tune of an average $20,967 in non-mortgage consumer debt. Between 2007 and mid-2014, Canada’s household debt-to-income ratio rose more than any other country outside of Greece. Canada is also one of a few countries in the Western world where household debt is actually higher than it was in the U.S. at the peak of the global credit bubble.
Lowering interest rates might encourage borrowing, but low interest rates also make it easier to manage bigger debt loads in the short term. That won’t be the case if the bank raises interest rates; interest-sensitive spending remains robust in Canada and any rise in interest rates will stretch Canadians thin.
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“Bank of Canada lowers overnight rate target by 1/4 percentage point to 1/4 per cent and, conditional on the inflation outlook, commits to hold current policy rate until the end of the second quarter of 2010,” Bank of Canada web site, April 21, 2009; https://www.bankofcanada.ca/2009/04/fad-press-release-2009-04-21/.
“Bank of Canada increases overnight rate target to 1 per cent, Bank of Canada web site,” September 8, 2010; https://www.bankofcanada.ca/2010/09/fad-press-release-2010-09-08/.
Evans, P., “Bank of Canada holds rate steady at 0.75%,” CBC web site, March 4, 2015; https://www.cbc.ca/news/business/bank-of-canada-holds-rate-steady-at-0-75-1.2981168.
“Canadian vehicle sales up 3.4% in February,” CBC web site, March 3, 2015; https://www.cbc.ca/news/business/canadian-vehicle-sales-up-3-4-in-february-1.2980369.
McMahon, T., “Canadian household debt grows almost 5 per cent in January, RBC says,” The Globe and Mail web site, March 5, 2015; https://www.theglobeandmail.com/report-on-business/economy/canadian-household-debt-growth-is-accelerating-says-rbc/article23311852/.