For the second time in a row, the Bank of Canada has raised its overnight lending rate – this time to by 25 basis points to 1%. The major commercial banks have responded to the back-to-back hikes (first in July and then in September) by raising their prime rates up to 3.2%.
The hike now reverses emergency rate cuts that were made back in 2015 when the economy was lagging and crude oil was trading at a multi-year low.
Similarly, the overnight lending rate sat at 1% during the depths of the financial crisis in 2009 – indicating we are still very close to record lows and we have a long way to go until we reach a so-called “normal” interest rate environment.
Understandably, the move has left many Canadians, especially those with a mortgage, wondering how this affects them and where interest rates are expected to go.
Bank Points to Strong Data and Inflation
In a statement released after the rate announcement, the Bank explains that better than expected GDP numbers and strong economic data from across the country support the Bank’s view that growth is becoming more “broadly-based” and “self-sustaining.” This has made conditions favourable for rate hikes, as the economy indicates it can handle them.
The Bank also says it’s been encouraged by better inflation, despite targets still not being met. In its statement, the Bank continues, “While inflation remains below the 2 per cent target, it has evolved largely as expected in July. There has been a slight increase in both total CPI and the Bank’s core measures of inflation, consistent with the dissipating negative impact of temporary price shocks and the absorption of economic slack.”
More Hikes to Come
Economists now say there’s a strong possibility the Bank could raise rates one more time in 2017, and they have two more chances to do so – on Oct. 25 and Dec. 6.
However, the recent increases have caused some apprehension. In a note sent after the last hike, BMO Chief Economist Doug Porter said this increase was abrupt and came with no prior communication since the previous meeting.
Since the increase in July, the Canadian dollar is up by almost 10%, currently trading comfortably over 80 cents U.S. But this may be a concern for the Canadian manufacturing sector as it relies on a stable currency to run business.
Porter says given “the Bank’s seeming care-free stance on the soaring Canadian dollar, we can’t rule out anything in coming meetings.”
Increased Cost for Borrowers but Some Good News for Buyers
Higher rates mean home owners and those with a floating rate loan (like a line of credit) will now face higher servicing costs. For example, due to the rate hikes, the cost to service a mortgage of $500, 000, with a mortgage rate tied to prime, will increase by about $100 per month.
On the other hand, potential homebuyers who have been sitting on the sidelines in hopes that prices would soften, may soon see the light. Higher borrowing rates could lead to cooling house prices, which we already saw after the first rate cut. The Bank, however, does believe current lower home prices are a combination of higher interest rates and a response to recent changes in tax and housing finance policies in parts of Canada.
What Canadians Can Do in Response to Rate Hikes
For anyone worried about how they will service their loans if rates increase again, the best advice is to make more lump sum payments now to bring down your principal as much as possible before another rate hike. That way, the impact of those higher rates will be cushioned by the fact that your overall loan is lower.
Furthermore, if you are looking for a loan, it’s imperative you calculate your affordability by accounting for a rate two percentage points higher than what the commercial banks are offering you. In this case, you are preparing yourself in the event future rate hikes.
Along with the rate announcement on Oct. 25, the Bank will also publish its Monetary Policy Review, giving a full update of its outlook on the economy and inflation, including risks to the projection.