How will clients be impacted by another interest rate hike?

With the Bank of Canada due to meet today, speculation around another interest rate hike is intensifying

How will clients be impacted by another interest rate hike?

With the Bank of Canada due to meet today, speculation around a potential second interest rate hike of the year is intensifying. Analysts had previously expected the central bank’s Governor Stephen Poloz to raise rates in October, but with Statistics Canada announcing unexpectedly positive results last week, some now believe that date will be brought forward.

At the same time, Canadian household debt continues to break records as the economy speeds along. Are Canadian consumers at risk of sliding into situations beyond their control if the central bank raises rates again?

“Although we are continuing to see higher debt levels, we have seen income levels pace well, too” said Cynthia Caskey, Vice President and Portfolio Manager for TD Waterhouse. “Ultimately, any major corrections in the housing market in the past have been based on employment and employment changes, and we have not seen any major employment dislocation. We don’t forecast a major drop in employment at this point, and that is the always the biggest factor at play for people running into problems with debt.”

As with the interest rate hike in July, any rise today would represent a change in strategy from of the BOC and the markets in general. Until recently, investors were not even pricing in a full 25 basis point hike for October or January of next year. In August, inflation looked muted and growth was challenged in Western Canada as oil continued to struggle.

Many experts expected the Bank of Canada to tread carefully in its tightening strategy. Back in early August, a second hike in September was almost unimaginable. Looking at T bills trading at the time illustrates the point: the three month spread asking rate was still at 75 basis points and the six month spread, for January 2018, was trading at 91 basis points - not necessarily baked in for a full move.

“Rising interest rates are going to play a role here in Canada, but they have been gradual so far and we expect that to continue when we look at what is priced into the market,” said Caskey. “Debt levels have been driven by housing, so debt is matched against assets, and that is better than just consuming. Because of that, there has been a gradual increase.”

In the short-term, Caskey expects another rise in mortgage rates to cause a flurry of activity in the housing market as buyers attempt to take advantage of the preapproval rates they’ve got locked in. Housing prices are beginning to moderate as the taxes on foreign inflows and buyers have an impact, and another hike could cause buyers to think twice about how they time the market.

Despite the perceived risks of another hike, Caskey believes it’s not all “doom and gloom”.  “When I look at the employment backdrop, how low interest rates are and how gradual it has been, I think there is some resilience here,” she says. “That’s not to say it’s not important to keep a close eye on leading indicators, like activity levels, to see if there is a drop.”

Related stories:
How the Bank of Canada changed tack on interest rates
Inside the fixed income strategy that ignores interest rates