Why Canadian Interest Rates Aren't Going Anywhere Fast

There has been much speculation on whether or not we would see interest rates increase in 2015. Since Stephen Poloz, the Governor of The Bank of Canada, took the helm of our countries most influential player in promoting the well being of the Canadian economy, his next moves have been under scrutiny. The Bank of Canada has frozen the key lending rates since September of 2010.  Will 2015 be the year that interest rates finally increase?  The Canadian economy is said to be strong and in recovery from the economic crisis of 2008.  It is likely that if interest rates do increase, we are only looking at a few basis points,which would have a negligible effect on the Canadian economy and this is likely to occur in the fourth quarter of 2015. With the declining price of oil per barrel reducing the economic output, the low interest rates will serve to off-set the reduced revenues through solid household spending, strong increased exports and investments.

The five years of low interest rates has encouraged household spending and economic growth. Consumers spending has increased injecting more money into the economy. The Industrial and manufacturing sector has also expanded and created more jobs. While household spending is increasing because of the low cost of borrowing money, average household debt is also increasing year over year. With ballooning household debt, any drastic increases in the interest rate could be catastrophic for the economy. A drastic increase in interest rates could put a squeeze on households, leaving some households with insufficient money to meet payment to creditors and other household financial obligations. However, most households can handle an increase of a few points.  Most residential mortgages are a fixed rate. Households with variable mortgages and Industry would are likely to feel the effects.

Housing prices in the GTA have remained strong. With demand exceeding supply there has been an upward pressure on home prices.  I suspect this will continue well into the third quarter of 2015. The low cost of borrowing has made home ownership, in this competitive market, possible. The low interest rates over the last 5 years have played a key role in this thriving housing market.  There is a strong correlation between housing prices and interest rates. Because most people have to finance the purchase of a home, they have to be able to carry the monthly loan obligations, if interest rates are high this increases the monthly obligation and could make carrying the same property in a low interest rate environment impossible. When interest rates increase, fewer people will be able to qualify for a mortgage which could create a soft housing market.  Any sudden increases to the interest rate would be a set -back to all of the progress made thus far.  Changes to interest rates are likely to be gradual over the next couple of years.

The declining price of oil has decreased the value of the Canadian Loonie, which sits at around US$0.89.  It has long been thought that there is a strong positive correlation between energy prices and the inflation or deflation of the Loonie.  Oil and gas make up a little over a third of Canada’s net exports, with the US being a consistent, stable purchaser of Canadian crude oil. The downward pressure on the Loonie will continue until oil production is adjusted to stabilize the price.  The depreciating Loonie will increase export revenues in 2015. Significantly increasing the interest rates would appreciate the Loonie. The Loonie would then be less competitive and export revenues would decrease.  This would not be advantageous for the Canadian Economy because it is already facing a projected over a $5Billion dollar reduction to GDP, according to one of Canada’s largest banks, due to declining price of oil.  Strong exports and foreign investment in the Canadian economy will cushion this blow.