After raising interest rates three times in 2017, the Bank of Canada held its key lending rate at 1.25% in March, with Stephen Poloz, the head of the bank, saying policy makers will “continue to monitor the economy’s sensitivity to higher interest rates.”1
But with the U.S. Federal Reserve storming ahead with its own rate hikes, it remains to be seen whether Poloz will follow suit or hang back. After all, the Canadian and U.S. economies are inexorably linked.
Most economists believe the Bank of Canada will raise interest rates twice in 2018: once in the second quarter and another in the fourth quarter, bringing the rates to 1.75% by the end of 2018.2
While the 2017 interest rate hikes came at a time of a strong job market and solid economic growth, the economy has cooled since then and policy makers are, as noted, cautious about further hikes.
No matter what Stephen Poloz decides though, the three interest rate hikes in 2017 are already having an impact on Canadian consumers and the economy. And any premature interest rate hikes in 2018 could further exacerbate the situation.
One reason for holding back on additional interest rate hikes is Canada’s soaring household debt levels. Collectively, Canadian household debt has increased to $1.8 trillion (including mortgages), up six percent from 2017. Some Canadians have reduced their debt, but 37% have added to it, lifting the average amount 3.3% to $22,837 per person—not including mortgages.
In 2017, the Bank of Canada estimated that 31% of residential mortgages with Canada’s big banks are up for renewal in the next one to three years.3 Higher interest rates mean those borrowers will be hit with higher monthly mortgage payments when it comes time to renew.
Higher interest rates may only tack on an additional $100 or so onto monthly mortgage payments, but that could stretch already cash-strapped Canadians to the limit. Roughly 33% of Canadians already say they are unable to cover their monthly bills and risk falling into a debt trap as they borrow more to make ends meet.
With interest rates on the rise, Canadians, and by extension the Canadian economy, could be at a major tipping point.
The housing boom in Toronto and Vancouver has slowed considerably, with both sales and housing prices falling considerably. The tighter lending rules and higher cost of borrowing is clearly getting in the way of first-time homebuyers.
This means some homebuyers will continue to work on saving a larger down payment before jumping onto the property ladder, which will result in lower sales in the first half of 2018.
This is important because real estate is a huge part of the Canadian economy, in fact, at the end of 2017, 22.68% of the country’s total gross domestic product (GDP) came from real estate transactions and related industries.4
To put that into perspective, in the U.S., it topped out at 21.5% in 2009, just before the housing bubble burst. Suffice it to say, the Canadian economy is very dependent on real estate. And rising interest rates are already having a negative impact on the real estate market.
Interest rate hikes have a huge impact on the Canadian dollar, especially rate hikes in the U.S. When the Federal Reserve raises U.S. interest rates it means the U.S. economy is doing well; this sends the U.S. dollar higher and puts pressure on the loonie.
Right now, one Canadian dollar is worth around US$0.77. Additional rate hikes in the U.S. would put further pressure on the Canadian dollar, unless Canada keeps pace and raises its interest rates. But with economic headwinds in Canada, this seems unlikely.
For now though, a weak loonie will help boost Canada’s export sector, which has long been underperforming. Despite ongoing uncertainty around NAFTA negotiations, a lower Canadian dollar makes our goods cheaper, which should, in theory, increase exports and juice the Canadian economy.
This sounds good on the surface, but a lower loonie means imported goods are more expensive, which boosts inflation.
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- “Bank of Canada maintains overnight rate target at 1 1/4 per cent,” Bank of Canada, March 7, 2018; https://www.bankofcanada.ca/2018/03/fad-press-release-2018-03-07/.
- “Bank of Canada to take cautious path with two more hikes in 2018: poll,” The Globe and Mail, February 27, 2018; https://www.theglobeandmail.com/report-on-business/economy/bank-of-canada-to-take-cautious-path-with-two-more-hikes-in-2018-poll/article38125220/.
- “Financial Systems Review,” Bank of Canada, November 2017; https://www.bankofcanada.ca/wp-content/uploads/2017/11/fsr-november2017.pdf.
- “Real Estate Drove A Fifth Of The Canadian Economy In 2017,” Better Dwelling, March 5, 2018; https://betterdwelling.com/real-estate-drove-fifth-canadian-economy-2017/#_.
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