The end of an interest rate era

On July 12th, the Bank of Canada confirmed what many had suspected for weeks; a 25 basis point increase in interest rates was confirmed, pulling the rate up to 0.75%. Weeks of pro-hike language and hinting gave the market plenty of time to anticipate and psychologically prepare for the increase. The immediate effect of the increase saw the Canadian dollar rise slightly, and the prime rates of Canada’s five major banks increase by 0.25 points as well. Tembo previously outlined that one of the reasons for a potential increase would be to ensure the value of the Canadian dollar remains stable as other central banks tighten their rates as well. (Higher rates at the Federal Reserve increase the value of the American dollar, putting downward pressure on the Canadian dollar and thus requiring our Central Bank to increase rates as well).

The increase was the first in over 7 years and brought an unprecedented period of rock bottom rates to an end. Throughout the early to mid 90s interest rates were in the double digits and averaged 3-5% in the early to mid 2000’s. Never in Canadian history had interest rates been so low for so long. With the increase, the Bank of Canada has followed its international counterparts in beginning the unwinding of easy money, reducing economic dependence on cheap debt, and preparing breathing space for lower rates in the future when the next economic headwinds arrive. The effect of the five big banks increasing their prime rates mean that variable rate mortgages will now be more expensive, making it slightly harder for first-time homebuyers to access credit.

Lines of credit, whether business or personal, will also be more expensive. Car lease rates will likely go up, and facility lines of credit will also go up. Commercial and business borrowing will be more expensive and this will have an impact on business bottom lines, hiring, long term spending plans, and investment strategies. Housing is just one piece of the borrowing picture. The positive aspect of the increase is that since the Bank began discussing the possibility of higher rates and now with the official announcement, the value of the Canadian dollar has recovered substantially. From a low point of 73 cents on the dollar in May, the dollar has risen to 78 cents recently. This will reduce pressure on prices, make imports cheaper, but will make exports more expensive for foreigners. Overall, it now appears that rates will likely return to more historical normal in the long term, the age of ultra low is now over.