2015 is expected to be the first time in five years that benchmark interest rates are moved upwards, increasing the cost of borrowing. The U.S. Federal Reserve will go first; the Bank of Canada is expected to follow.
Most analysts expect the Fed to increase its key rate, which has been near zero for six years, by a quarter of a percentage point in the spring. Then, unless there is an unexpected shock to the U.S. economy, it will likely boost it gradually throughout the year, though the top rate is still expected to be a modest 1.25 to 1.50 per cent by the end of the year.
Canada will almost certainly follow, though with a time lag, depending on the state of the economy here.
Whenever it happens will be a shock to people carrying consumer debt, says Lynnette Purda, an associate professor at the Queen’s School of Business.
The interest rates on consumer loans, lines of credit, variable rate mortgages and some auto loans could rise immediately. For Canadians carrying consumer debt that will mean higher payments.
“Despite the low interest rates we’ve had for years, no one seems to have worked away at their debt levels. It will be a wake-up call for many consumers,” Purda told CBC News.
Consumers could pull back
Purda expects Canadians will pull back on big ticket purchases, like cars, appliances and furniture as interest rates rise.
And the biggest ticket purchase of all, housing, will not be unscathed. Overheated markets will finally cool and we may finally see the “soft landing” long predicted by the Bank of Canada and economists.
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The timing of the interest rate increase – which has been predicted in past years without materializing – is no sure thing.
Although the U.S. Fed at its last rate announcement indicated it was most likely to move in the second quarter of 2015, much depends on economic indicators. Low oil prices have given a boost to the U.S. economy and left more money in people’s pockets, so there is a possibility the Fed could move even sooner.
TD Bank is predicting the Bank of Canada won’t move at the same time as the U.S. even though Canadian rates usually track what is happening in the U.S.
According to TD economist Leslie Preston, the rise may not happen here until the third quarter.
“We expect Canada to raise interest rates in October of 2015 – we expect two [quarter of a percentage] point interest rate hikes in the fourth quarter of 2015, so by the end of 2015, the overnight rate would be at 1.5 per cent – it’s currently at one per cent,” she told CBC News.
The challenge for Stephen Poloz
For Bank of Canada governor Stephen Poloz, this will be the first time he’s wielded one of the key tools in a central banker’s arsenal – the overnight interest rate which is the rate the central bank uses to lend to financial institutions.
And he’ll have to weigh inflation that currently seems quite high against the potential economic impact of higher rates.
The labour market is not yet operating near capacity, with many people still unemployed or underemployed, Preston said. And falling oil prices may slow capital spending and hiring, both in the oil patch and in sectors that supply it, such as equipment manufacturing.
“One of the challenges that emerged most recently are lower oil prices. Canada is a net oil exporter so when prices go down, it affects growth in Canada. This is a new headwind that’s come up,” Preston said.
While those factors may slow the Bank of Canada’s decision to raise rates, bond yields could rise in anticipation of a rate hike and that would affect fixed mortgage rates, according to RBC chief economist Craig Wright.
Wright said the rise in bond yields could catch people by surprise, as it may precede the Fed’s move on rates. Those who are looking to renew a mortgage in 2015 should watch what the banks do with their fixed mortgage rates, he said.
Renewing a mortgage? Lock in early
“What you tend to see is people anticipate a rise in mortgage rates and lock in,” he said, adding that only about 20 per cent of mortgage holders renew each year, so relatively few people will be affected.
'The other side of higher interest rates is it would make life a little easier for a lot of pension funds or savers – the saving side of the economy has been struggling to get returns' - TD Bank economist Leslie Preston
Wright warns that people with credit card debt, auto loans and lines of credits are "vulnerable" to a rate hike, especially if they have high levels of debt.
But he is upbeat about prospects for the Canadian economy, saying it is likely to continue improving, with new jobs emerging in the manufacturing sector because of the lower dollar and growing exports. People who are employed are less likely to get in trouble amid rising rates, he says.
He believes Canadian companies will shrug off an interest rate hike and keep investing.
“Companies have a lot of cash to work with. As the economy improves we will be looking for them to build their businesses,” Wright said.
Wright sees the Canadian dollar headed lower next year, possibly below 84 cents US. That makes Canadian exports more competitive.
Upside of higher rates
“Higher rates have an important upside. If they are low for too long, we see bubbles appearing,” Wright said.
He points to the housing market as an example with certain markets overheated because rates are low. Higher rates should help correct any bubble in housing markets, he said.
An interest rate hike could also temper inflation, which is pushing the Bank of Canada’s two per cent target despite lower oil prices.
Preston also sees an upside for savers who want a safe haven for their money.
'"The other side of higher interest rates is it would make life a little easier for a lot of pension funds or savers – the saving side of the economy has been struggling to get returns in a low-interest rate environment,” she said.