Friday, 12 October 2018

CANADIANS NEED (AND DESERVE) HIGHER INTEREST RATES


For more for than 10 years, Canadians have enjoyed record low rates, borrowing until their heart's content.  That has left Canadians with record high debt and sent housing costs soaring in major Canadian cities.

But the days of cheap money are coming to end.  

The economy is doing well, unemployment is near a record low and inflation is in check. Added to this, south of the border the U.S. Federal Reserve continues to raise its benchmark interest rate and Canada has finally hammered out a new deal with the U.S. that will replace the old North American Free Trade Agreement or NAFTA.  

Called the United States Mexico Canada Agreement or USMCA, it lays out what our trade relationship with the U.S will look like going forward.   Good or bad, Canadian businesses and investors now have certainty. This means they can invest with confidence and make better decisions about their money.

The lack of trade policy decision was seen as a major roadblock
to raising rates. After the last interest rate meeting, when the Bank left rates unchanged at 1.5 per cent, the Bank noted, that it’s “monitoring closely the course of NAFTA negotiations and other trade policy developments, and their impact on the inflation outlook.”

Bank of Canada Governor Stephen Poloz has shown concern that the lag on negotiating on NAFTA was weighing on business investment decisions as well. Both domestic and especially foreign. With those concerns now lifted, business investment is expected to pick up.

Added to that Canada’s Gross Domestic Product (GDP) grew twice as fast in the second quarter compared to the first, accelerating to 2.9 per cent.
Exports to the U.S. are up as well.

All of this points to higher rates soon and fast. 

In his special report on the USMCA, BMO Chief Economist Douglas Porter says this move, along with recent positive economic data in Canada this “all but cements a rate hike at the next policy announcement on October 24, barring something truly shocking over the next three weeks.” Looking further down the road, most of the downside risk to the economy has been cleared. Porter says BMO economics is “now calling for three rate hikes in 2019 (January, April, and July).”

If that forecast is right, at this time next year, Canadians will be paying at least one percentage point more to service debt.

Many might be concerned about what higher rates will do to our economy and homeowner’s ability to service debt.   In some cases, they can be angry that rates are predicted to go up so fast, after remaining so low for so long. Also considering the Bank of Canada has already raised rates four times since July 2017.

Those higher rates are already affecting Canadians right now. A report by Environics Analytics shows Canadians are starting to feel the “sting” of rising interest rates.  In the report, it says, “Increasing debt levels coupled with rising interest rates mean the average Canadian household spent $544 more on interest charges in 2017.”


Some part of Canada are harder hit, the Environics report says “The effects of rising interest rates were particularly acute in Vancouver, where households on average incurred an additional $1,152 in interest charges. Overall, Canadians paid $9.0 billion more in interest charges in 2017 than they did the prior year.”

Despite all this, Canadians need higher rates, to pump the brakes on our out of control indebtedness and penchant to rely on credit to fund our lifestyle.
If Canada fails to raise rates we could face other problems. Like spiking inflation and excessive risk-taking and artificial bubbles.  A report back in 2013 by the CD Howe Institute called, “The Dangers of an Extended Period of Low Interest Rates: Why the Bank of Canada Should Start Raising Them Now,” warned of just that.

More than five years have passed since it was published.
Since then Canada has seen two emergency rate cuts by the Bank of Canada in 2015.

So rates are going higher, and an entire generation of borrowers is going to witness what it feels like to pay more to service their mortgage when they go to renew and there is a huge segment of Canadians that will be renewing soon if not already this year.

A recent CIBC report estimates that nearly half of (47 per cent) of all existing mortgage will be up for renewal in this year. That is almost double the average mortgage that is renewed every year. Many Canadians have been enticed by lower rates for shorter terms, effectively creating a glut for 2018 of the number of loans that need refinancing.

For many of those that took out a mortgage before the new rules came into effect, they may feel stuck. Some, mortgage holders will find it hard to shop around as moving your mortgage to a new lender means going through the stress test the Federal Government brought in this year. High ratio mortgage holders might fail the new test, even after year r of paying their original mortgage down.

Renewal or not, these ultra-low rates have created a generation of people who have no idea how to function in a higher interest rate environment. For the last decade, rates have only gone down and investments have only gone up. We have been winning all the time everywhere.

Over the summer federal analysis by the Finance Department revealed their concern of how higher rates will impact “highly indebted households.” These are homes that have debt-to-income levels of at least 350 per cent. According to the report, 12 per cent of all Canadian households finds themselves in this situation.  These households are middle-income earners under the age of 45 are likely self-employed and live in Ontario or British Columbia. 

But, higher interest rates will immediately get Canadians thinking more about paying debt down, saving more and being more careful when borrowing.
When rates shot up to more than 22 per cent in the early 1980s Canadians reacted by saving more and paying off debt. Then, Canadians were socking away 19 per cent of their savings. With lower rates today and little incentive to save, Canadians today are barely putting away 5 per cent of their earning. Creating more issues in the years to come with retirement income.

The economy is poised and ready to raise rates, and Canadians deserve, if not for anything but to learn how to operate in a normal interest rate environment.


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