Bank of Canada Needs to Raise Interest Rates to Curb Decades-High Inflation
In an effort to stave off an economic meltdown during the 2008 financial crisis and 2020 pandemic, the Bank of Canada, U.S. Federal Reserve, and other central banks around the world, cut their key overnight lending rates to historic lows.
Why? Low interest rates make it easier for individuals and businesses to borrow, which in theory, helps juice economic growth. Interest rates that are artificially low for too long though can lead to an overheated economy. And that’s what we’re experiencing.
Why Is The Bank of Canada Raising Interest Rates?
In June, Canada’s inflation rate hit a four decade high of 8.1%. While Canada’s inflation rate cooled to 7.6% in July, it’s still untenably high, at its third highest point over the last four decades. It’s also more than double the 3.7% mark from a year ago. And it’s made everything from gas to cars, food, housing, and clothing a lot more expensive.
To combat runaway inflation and cool economic growth, the Bank of Canada has been raising its key lending rate at a torrid pace. During the pandemic the Bank of Canada lowered and held its interest rate at 0.25%.
But since March 2022, the central banks has raised its policy rate by 300 basis points, the fastest pace since the mid-1990s, in an effort to bring inflation down to its mandated target of two percent. Most recently, on September 7, 2022, the Bank of Canada hiked its key overnight lending rate by 75 basis points to 3.25% from 2.5%.
Not only does inflation make things more expensive, so too does higher interest rates. Canadian banks generally charge a two percent premium over what the Bank of Canada’s key lending rate is, and that’s for their prime borrowers.
Decades-high inflation and rising interest rates is a new concept for many Canadians. In fact, an entire generation of Canadians, those under the age of 40, have never experienced this kind of inflation. And it’s having a big effect on those who accumulated large amounts of debt.
According to Statistics Canada, debt to household disposable income rose to 181.7% in the second quarter, up from 179.7% in the first quarter. That means Canadian households have $1.82 in debt for every dollar of disposable income. To service that debt, roughly 7.3 million Canadians over the age of 18 have taken out loans or used their credit cards to keep up with inflation.
While rising interest rates are painful for consumers, they are needed to help slow surging inflation. It will take time though and the sharp increase in interest rates is expected to slow Canada’s economic growth in the back half of 2022.
A recession may actually be needed to bring inflation back down to two percent. A recent study suggests that a recession is virtually unavoidable. Each time the Bank of Canada has quickly raised its overnight lending rate over the last 60 years, it’s led to a recession.
In addition to putting the brakes on inflation, and despite fears of a recession, there are some benefits to rising interest rates. Whether you’re just getting started or are a seasoned investor, interest rates are important. That’s because they help generate income that can help support your retirement.
Unfortunately, over the last 15 years, low interest rates have taken the income out of income investing in securities like bonds, treasuries, and GICs. But with rates rising, maybe for years, fixed income assets are becoming more attractive. There are also a large number of other investments that do well in a rising interest rate environment.
Sharp Asset Management for Your Retirement Planning
Ultra low interest rates are good when the economy is doing poorly, but when it’s heating up, rising interest rates are an important tool for moderating economic growth. Rising interest rates also have an immediate impact on the stock market.
If you live in Toronto, Mississauga, or anywhere in the GTA and are looking for a portfolio management firm or asset management company to help you build a diversified retirement portfolio designed to suit your investment goals, Sharp Asset Management can help.
Sharp Asset Management Inc. is an independent portfolio management firm that is 100% owner-operated. Since we are a highly concentrated group of professionals, we can respond quickly to changing market conditions.
Sharp Asset Management is not affiliated with any financial institution, securities firm, or mutual fund company. Nor do we earn any commissions or fees on investments we choose for our clients. That means our team of wealth management professionals is focused exclusively on helping you achieve your unique, long-term investing objectives. To learn more about investing with Sharp Asset Management, contact us today.