You are to be forgiven if you are having a hard time trying to sort out all the conflicting news about interest rates and inflation. You’re not alone. Even the experts frequently disagree.
This is an important issue for entrepreneurs and investors as many of us borrow money – either personally or corporately (likely both!).
We’ll try to clear up the confusion and offer some perspective on what the future holds for the balance of 2010.
Last week, the Bank of Canada sent out signals that rates may rise this summer. Yet south of the border, Ben Bernanke, Chairman of the US Federal Reserve, said last week that “record-low interest rates are still needed to ensure that the economic recovery will last and to help ease the sting of high unemployment”.
Remember that interest rates on both of sides of the border are at “emergency” levels. Increases, if any, are much less about inflation and more about taking the foot off the accelerator and putting the car in “neutral” before putting the brakes on.
The Bank of Canada pledged last spring not to increase interest rates until June, 2010. Therefore, there is more pressure than usual for them to signal to what lies ahead between now and June. This week, the Bank said that “Canadians should prepare for higher rates”. This news came as no surprise to the market including our bond manager Addenda Capital, who reminded us that they expected rates “to be normalized” and this latest news did not change their view “on the timing of rate hikes after June”.
Canada has never started to increase rates before the US. But it will likely happen this time. Circumstances are different in Canada. Our housing market is almost too hot and our recovery looks stronger.
Now to the next issue – which rates and by how much? The increases will be small and slow and they will mostly affect the short term rates i.e. those between 30 days to 2 years. The increases will likely come in 0.25% increments, to a maximum of 0.75%.
How will you be affected? You will see matching increases if you have loans based on the Prime rate. There will be fewer 0% loans from car dealers and variable rate mortgages will be more expensive. Fixed rate mortgages and bond portfolios will be less affected, at least in the short term.
Have you been debating switching from variable to fixed rate debt? This may be the time to make this move.
Further increases in 2010 are unlikely – for a host of reasons. Firstly, there is little inflation. Secondly, it will put us more out of step with the US, with whom one-fifth of our economy depends. And lastly, higher rates will put upward pressure on the Canadian dollar and damage our export trade.
Did you notice that our dollar has climbed almost 2 cents since the Bank of Canada spoke out? This will not go unnoticed by them!
Inflation will determine rates beyond 2010. If it is held in the 2% range, it is reasonable to expect rates to hold at these levels.
So in summary, expect modest increases in short term interest rates in Canada, starting this summer. Beyond that, keep your eye on inflation for the magnitude and direction of further changes.
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