Dating back to the summer of 2017, we have seen 4 interest rate hikes. On Wednesday, October 24, the Bank of Canada raised interest rates for the 5th time, to the current level of 1.75%. Prior to July 13, 2017, the central rate was 0.5%.
This 1.75% is called the Bank of Canada rate. This is the rate which the chartered banks pay when borrowing money from the Bank of Canada. The BoC rate has not been this high in almost a decade, dating back to December of 2008.
The BoC rate is the basis for the prime rate (also known as bank rate). The prime rate has increased along with the bank rate and now sits at 3.95%. Below is a chart showing the history of the prime rate, not taking into account the most recent increase:
These increases play a major role in the ability for people to continue to afford the mortgages, consumer, and student debt they hold. Anyone holding a mortgage/loan with a variable rate will feel the pinch in their budget as their interest rate is adjusted for these increases immediately.
Both the Federal Reserve in the US and the Bank of Canada have indicated that interest rates will increase more over the next 6 months. How big those rate hikes will be and exactly when they will occur is unknown.
Stephen Poloz, the Governor of Canada’s central bank, has indicated that rates will return to their neutral rate. This is a place where the cost of money is neither stipulating expansion or curbing growth. Neutral rates meaning, that the Bank of Canada rate would probably be in the 2.5-3.5% range.
The Bank of Canada has been anticipating these interest rate hikes for quite a while. As such, they implemented the mortgage stress test. This stress test takes the current 5-year rate + 2%. A person must be able to afford interest payments at that level to be approved for a mortgage.
For the last 10 years, savers have been forced to accept very low-interest rates when compared to historical averages. As a reference, the long-term Canada Bond rate has averaged about 5% interest over the last 50 years.
On the other hand, borrowers have had nearly a decade of extremely low interest rates. With such low-interest rate loans, it has fueled an explosion in the price of farmland, residential and commercial real estate, and stocks. However, interest rates as low as we have seen for the last decade are not sustainable. A more realistically sustainable rate would be a prime rate in the 5-6% range.
Business owners, investors, and investment managers should be analyzing businesses and investment opportunities on a “what if” basis. What impact will current prime + 3% have on the future profitability of a business or particular investment?
Please reach out to us if you’d like to have our input on the impact of increasing interest rates on your particular business, investment portfolio, or future investment opportunity. We would be happy to take a look and provide some insight!
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Disclaimer: This Forbes Wealth Blog is for informational purposes only and does not constitute financial, legal, or tax advice of any kind. Please consult your legal, accounting, tax, investment, banking, and life insurance professionals to get precise advice relating to your particular situation before acting upon any strategy.