July 11, 2018

Bank of Canada Hikes Rate to 1.5% in July Announcement

Growing trade volatility and tariff threats weren’t enough to sway the Bank of Canada from its upward swing: the central bank, which sets the cost of borrowing for all lenders in the nation, has hiked its trend-setting interest rate to 1.5 per cent from 1.25 per cent, where it had been set since January.

While the BoC conceded that the “possibility of more trade protectionism is the most important threat to global prospects”, stronger domestic economic data was too strong to ignore; inflation continues to run close to 2 per cent, boosted by higher energy and commodity prices, while job numbers improve. Rate hikes by the BoC’s U.S. counterpart, the Federal Reserve, have also paved the way for a rate hike, as putting off tighter monetary policy on this side of the border would have further depressed the Canadian dollar.

That’s led the BoC’s governing council to go ahead with the widely-expected hike, and indicate that more will be on the way. However, it does acknowledge Canadians are still absorbing the higher borrowing costs already introduced this year, as well as trade-related anxiety.

“In particular, the Bank is monitoring the economy’s adjustment to higher interest rates and the evolution of capacity and wage pressures, as well as the response of companies and consumers to trade actions,” it stated in its release, adding that anticipated steel and aluminum tariffs will spell “difficult adjustments for some industries and their workers.”

Related Read: Should Mortgage Borrowers Go Fixed or Variable as Rates Rise?

Strong Data Mean More Hikes to Come

However, the key indicators remain strong, prompting the BoC to believe any negative impact will be modest, citing an economy operating close to capacity, stabilizing housing market, and improved business investment.

The BoC forecasts the economy will grow by 2.8 per cent in the second quarter of this year, followed by 1.5 per cent in Q3, with overall growth to average right on target, around 2 per cent. It says this projection bakes in uncertainty over impending tariffs and impact on affected industries.

There was much “will they or won’t they” speculation leading up to this rate announcement; while early predictions widely called for a hike, that was thrown into flux following Trump’s inflammatory remarks regarding the U.S.-Canada trade relationship at the G7 summit, and increasingly aggressive trade policies.

However, the BoC maintained in public remarks that it was committed to data-dependent guidance, prompting economists to again side with a hike after a slew of positive economic data was released. Initially, three hikes were called for in 2018: the first occurred in January, and the third is widely anticipated in October, with another three in 2019 should the data support it.

How Will This Impact Borrowers?

Because the Bank of Canada influences the interest rate pricing at Canada’s consumer lenders, the cost of variable borrowing will rise following this rate announcement. The “Big Six” banks – Bank of Montreal, Scotiabank, TD, National Bank, CIBC and Royal Bank – are highly expected to factor the full hike into their Prime Rates, currently at 3.45 per cent. Should they follow the example set in following January’s rate hike, consumers can expect Prime to rise to 3.7 per cent in the very short term.

UPDATE: Effective Thursday, July 12, each of the Big Six have increased their Prime borrowing rate to 3.7 per cent, effective immediately.

While fixed-rate borrowers will not be directly impacted by today’s rate hike, they will experience the residual effects of an overall higher borrowing environment. Because fixed mortgage rates are influenced by the yield coupons on Government of Canada bonds, which are expected to rise following this announcement, those at the renewal or refinance stage may encounter higher fixed rates.

A Tougher Stress Test to Come

As well, it may make things tougher for applicants of new mortgages to qualify: the “stress test” rate – otherwise known as the Bank of Canada’s five-year posted rate – rises in tandem with the Big Six’s posted fixed rates (it’s based on their average), meaning any upward movement on their part will be factored into the threshold Canadian mortgage borrowers must satisfy to receive home financing.

In short, interest rates are set to rise for the long-term, and all mortgage borrowers will be impacted in some way.

Related Read: Bank of Canada Increases Stress Test Rate