Over the last several weeks the Bank of Canada has shifted the tone of its messaging to indicate a rate hike is on the horizon. As a result, experts are anticipating a 25 basis point increase to be announced as soon as July 12th.
A shocker? Not exactly.
The prospect of rising interest rates has been discussed (and delayed) for years as the Canadian economy vacillates between anemic underperformer and hopeful yet sluggish grower. Ultimately a move higher represents a belief by the Bank that Canadian businesses and consumers can stomach the tightening. However certain players are bound to benefit while others will suffer. Click here to view an article from The Financial Post that provides an effective review of both camps.
1) The Banks and Life Insurance Companies
- Both banks and life insurance companies will benefit from rising interest rates
- Rising rates will alleviate pressure on the Banks’ net interest margins (the difference between interest earned from making loans and interest they pay on deposits)
- Given the long term nature of life insurance companies liabilities combined with the relative short term nature of their investments, rising rates will allow them to re-price assets at higher levels compared to where they were set when the contracts were written
- Monthly mortgage payments will rise, but not in a substantial way
- According to Rob McLister, founder of RateSpy.com, a quarter-point increase in rates would increase the typical mortgage payment by roughly $24 (based on a $200,000 mortgage at 2.15 per cent with between 14 and 19 years remaining)
- McLister believes that one or two rate hikes won’t be enough to materially affect the economy. However an increase of 75-100 basis points would generate a ‘perceptible drag on sales’
3) Savers and Pension Funds
- Consumer savings accounts are unlikely to benefit from rising rates since banks will increase their rates on loans but not on their deposits (according to Barclays analyst John Aiken)
- However fixed-income yields will rise (including on GICs and money market funds) which is a boon to ultra-conservative investors
- Defined-benefit pension plans (and the companies that still offer them) will benefit since higher rates will reduce the amount of capital required to meet their long-term obligations
- Since they are net borrowers, rising interest rates tend to put more pressure on government agencies, forcing them to spend more money on servicing existing debts
- A higher proportion of tax revenues being used to pay off loans means a smaller proportion going to government programs
When interest rates finally rise, the news is likely to generate considerable noise; even at 25 basis points. However given the Bank of Canada’s measured and conservative approach to policy management that has persisted for nearly a decade, the tangible repercussions experienced by the end consumer is likely to be limited at best.