In an indulgent age, when everyone wants you to borrow just a little bit more, central bankers are here to offer discipline.

U.S. Federal Reserve chair Janet Yellen proved it yesterday, raising rates by another quarter of a percent.

Her opposite number north of the border, Bank of Canada governor Stephen Poloz this week offered broad hints that he too will begin raising rates sooner rather that later.

And whether Poloz makes his move or not, Canadian borrowers will inevitably begin to feel the pinch as rising U.S. rates increase the cost of borrowing for Canadian banks. Those are costs that they will, at some point, be forced to pass on to borrowers.

Gutsy stance

Although borrowers won't like it, Yellen took a gutsy stance in the face of some confusing economic data. 

Essentially, the U.S. chief central banker ignored what is supposed to be the key indicator of whether the Fed should adjust rates. That indicator — inflation — has not been climbing towards the bank's target rate of two per cent. In fact, it has been going in the opposite direction.

That fact has been used by some business commentators to insist that Yellen has moved too soon. At yesterday's news conference, financial reporters repeatedly questioned her actions in light of low inflation.

Yellen had two main reasons for overruling the inflationary evidence.

She blamed most of the drop in inflation to a quirk: an across-the-board decline in U.S. mobile telephone charges in March had a one-time effect on spending costs strong enough to impact the consumer price index. A similar one-time drop in drug prices compounded the effect.

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Yellen blamed a one-time plunge in U.S. cellphone charges plus a fall in the cost of drugs for a sharp drop in inflation that will have washed out of the statistics by next year. (Aristide Economopoulos/Reuters)

The other is the economy. She predicts that economic growth and new investment mean that inflation will bounce back after those one-time March price declines work their way out of the annual statistics.

But she insists the strongest indicators that inflation is on its way UP is a tight job market — and not just because of a persistent low unemployment rate of 4.3 percent.   

"Whether it's household perceptions or the availability of jobs, difficulty that firms report in hiring workers, the rate at which workers are quitting their jobs, the rate of job openings — all of these indicators do signal a tight labour market," said Yellen.

A tight Canadian labour market is one of the things that Poloz and his deputy Carolyn Wilkins say show Canadian rates have to rise.  

Not party time

"It isn't time to throw a party, but it does suggest that the interest rate cuts we did two years ago have done their job," said Poloz in an interview with CBC Winnipeg on Tuesday.

Except for those hoping for a better return on cash savings, Canadians, who notoriously carry heavy debt loads, are unlikely to be throwing any parties over higher interest rates.

"People need to be thinking about what their finances would look like were interest rates to be a little higher when they renew their mortgage," Poloz warned in the CBC interview.

Toronto Real Estate

Canadians are still going deep into debt to buy real estate, but as Fed Chair Janet Yellen raises rates and the Bank of Canada talks of doing the same thing the party may soon be over. (Graeme Roy/Canadian Press)

In fact, central bankers who raise rates have a traditional image as party poopers, taking away the punch bowl just as things start to get lively.

For overborrowed Canadian consumers constantly being told they can have it all, Yellen and Poloz are like the doctor reminding you to cut down on sausages and sugary drinks before it's too late.

"We want to keep the expansion on a sustainable path," Yellen warned, saying a too-rapid rise in rates risks triggering a recession. 

Money is still cheap

As Yellen explained, the latest rise in interest rates, and even the one after that still expected for later this year, will by no means slam the brakes on the economy. 

In Fed-speak, interest rates of 1.25 per cent are "still ​accommodative," — that is, below what the true cost of borrowing should be. In other words, for companies looking to make new investments, money is still cheap. For now, at least.

Yellen says those unnaturally low interest rates are just a distortion caused by emergency action by the Fed to rescue the economy in 2008. 

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Bank of Canada governor Stephen Poloz is happy that the economy is back on track, but overborrowed Canadians will be in no mood to party. (Chris Wattie/Reuters)

Unless something unexpected happens to the economy, Yellen says the gradual process of bringing the economy back to normal is to keep raising interest rates for next several years.

But fixing interest rates isn't the only remnant of the 2008 crash she faces. The process of quantitative easing, where the U.S. central bank bought up bonds to help flood the economy with cash, has left $4.5 trillion US on the Fed's balance sheet.

Yesterday Yellen spelled out a plan to unwind that gargantuan debt pile back onto the market little by little, in a way that will be so boring that it will be like "watching paint dry," she promised.

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