Canadians’ Debts Will Soon Cost More

What has long been expected has finally been officially announced: interest rates have increased by 25 basis points. After more than a year, Canadians will have to adjust to higher costs of borrowing for everything from credit cards, to lines of credit, to mortgages.

According to the Bank of Canada, the pace of economic growth, the soaring Canadian dollar, and inflation jitters all have helped spike the interest rate hike. However, the question is whether future interest rate hikes are also in the cards.

Fiscal policy is a difficult balancing act. What has spooked the Bank of Canada? Well, it was a relatively short stretch between moderate increases in core inflation and the non-relenting Canadian dollar that left Canadian exporters with black eyes and bloodied noses.

What makes fiscal policy decisions tricky is their timing. If inflation is rising only moderately, and if the economy is not pumping as strongly, then interest rates going up even just one time too many could cause the policy to overshoot the landing and, in effect, stall the economy instead of simply moderating its pace.

Before the Tuesday increase of 25 basis points, economists more or less agreed that another increase was to be expected in September, and a few more after that. Not surprisingly, currency traders pushed the Canadian dollar further up ahead of the announcement. Their optimism was also boosted by a strong labor market in Canada and increasing wages.

And then, just yesterday, the odds that interest rates would keep going up deflated, sending the Canadian dollar into a nosedive to its worst performance among the world’s currencies. Apparently, the Bank of Canada said that only moderate interest rate hikes are needed to cool the economy.

I’d have to say, why hike interest rates at all? True, inflation has stepped slightly over the average annual rate of two percent. However, in spite of the Canadian economy doing an okay job so far, and especially in comparison to the U.S. economy, it is still far from being a red-hot economy.

Our labor market is churning out jobs, but within an expected range. Canadian corporate earnings are expected to grow after their dismal performance for the first half of the year. Yet, again, it is hardly going to be the spectacular growth of over 20% we enjoyed only a couple of years ago. This should hardly come as a surprise, considering corporate Canada is hollowing out and that basically only two sectors are supplying fuel to Canada’s stock markets: resource and financial stocks.

I’m not a proud owner of a crystal ball, so bear with me on this one. I don’t believe interest rates will be hiked again in September. And while Canadians’ debts will cost more in the coming months, let us not forget that we are still operating within an environment with very low rates of interest.