Interest rates could be on a roller coaster

Canada and U.S. diverge on where to set policy

By Paul Marck

Got your banking in order? What, you mean you don’t have your long-range plans set for getting that new credit facility or line of credit under wraps before the expected Bank of Canada rate hike on June 1?

Well, maybe it won’t be such a big deal. If you have been following Bank of Canada Governor Mark Carney’s signals for the last six or so months, you know that he has been fretting about interest rates, ever since last summer’s setting of  the record low .25 per cent overnight rate for the major banks. And from that, Canadian consumers and businesses have enjoyed the lowest interest rates in more than half a century. I remember my parents telling me when they bought their house in the mid-1950s what a great bargain it was when they had a long-term mortgage set at 5 per cent. And I also remember the 18.75 per cent mortgage on my first house in the early-’80s,when inflation and interest rates were doing nothing but climbing like a Saturn rocket. But, I digress.

Worried about a housing bubble and escalating inflation, Carney took steps last fall to tighten up credit, first using the Bank’s influence to have mortgage eligibility rules modified. Those changes came into effect a few weeks ago, whereby first-time buyers are required to provide bigger down payments and adhere to five-year rates, rather than discounted short-term or blended rates. The intent is prevent those optimistic first-time buyers from becoming house-rich, cash-poor and ultimately to avoid a housing crash like the U.S. experienced throughout the 2008-09 recession.

Now Carney’s plan is to hike rates, starting in June, a bit earlier than the originally promised one-year rate moratorium through July. Trouble is, the mere announcement that the country could undergo a rate increase shot the value of the loonie up to parity with the U.S. buck — an anticipated but unwanted outcome. Plus the big banks started increasing mortgage rates practically immediately, based on all that murky mumbo-jumbo about bond rates, etc. etc.

But consumers don’t seem to care, as at least two surveys in April indicate that they are willing to absorb interest-rate increases over the short term. The only real question is whether the Bank of Canada starts the interest-rate climb with .25- or .50-basis point rise to start. Frankly, and it’s only a guess — I am anticipating the Bank will bump rates up by .25 — and then leave it alone and forget about further increases for a while.

There are a few reasons to believe this: We still have high unemployment in Canada; It is in nobody’s interest to have the Canadian dollar soar over the U.S. greenback; plus, the U.S. will not follow suit with interest-rate hikes. The Fed has indicated that so long as U.S. unemployment remains high, as long as the American economy is sluggish, as long as there is a need for stimulation in their economy, rates south of the border will not rise.

So, the Bank of Canada can save face and keep its credibility by delivering on a rate rise, even if it is only a symbolic gesture. But without the U.S. matching Canada’s strategy, it’s not likely to go much beyond that, because an overheated Canadian economy, while the U.S. remains lukewarm at best, is not a desired outcome.

We should know in the next couple of months whether this (fearless, foolish — you pick) prognostication comes to pass.

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