What Happens With Low Rates

The Bank of Canada Governor, Mark Carney, has been warning Canadians for a while now that we will be in a low interest rate environment for a few years.  He has clarified that by "low" he means lower than average, not necessarily as low as interest rates have been over the past 2 years.

This past week a deputy governor at the Bank of Canada also spoke about low rates and their impact, warning that while usually good for the economy, people's behaviour can create risk during low rate times.

The following is a short list of impacts that low rates have on the economy:
Low Inflation - The Bank of Canada is trying to keep inflation between 1% & 3% annually.  They can influence this by increasing or decreasing the Bank of Canada overnight rate, which is the rate the BoC charges Banks for borrowing money from them to cover some daily incidentals.  Because inflation has been very low for the past 2 years, the BoC rate has been very low.  This means it costs the banks less to borrow money, and the lower cost is passed on to consumers and businesses through lower loan costs.


Stimulates the economy - This low cost of borrowing (ideally) encourages businesses to borrow to purchase new equipment and build new buildings, thus creating jobs and helping the economy grow.   The low rate also encourages people to borrow to build homes and purchase things, which also creates jobs and helps grow the economy.

Corporate risks - If businesses are concerned that they don't think they can grow or get a reasonable return, they will not build or buy new equipment, no matter how good the borrowing rate is. It appears that generally quite a few companies are coming out of this anxiety phase and starting to purchase equipment (manufacturing, computers...) and do some hiring.  The inexpensive debt allows them to invest in themselves fairly cheaply.

Consumer risks - there is some good and bad here.
·    Debt - Low rates encourage consumers to spend, which helps the economy.  However, many consumers already significant debt loads before the rates dropped.  Since the average Canadian has increased their debt to annual income ratio to about 1.5, that is an average of Canadian adults have debt of about 1.5 times their annual gross income.  This is officially higher than the Americans and is a concern because it is not sustainable.  People have borrowed for larger houses, newer vehicles, bigger TVs, and more trips, and this is adding up.  The Bank of Canada is concerned that as rates begin to rise that many Canadians will struggle to meet their debt obligations, so they have been encouraging consumers and banks to exercise fiscal restraint concerning growing debt.
·    Savings & Investing - With rates this low, many people have looked at their investment returns and just groaned as they have seen very little growth on their GICs and many mutual funds.  This has resulted in 2 things that are worrisome

• o    To get the returns people were used to in the 1990's  investors are taking on more risk than they normally would, especially those who see retirement only a few years away.  They are trying to get their nest egg to grow quickly, which means putting their savings into more volatile investments to get higher returns.  But, as we've seen in the past 3 years, things that go up can also go down.  
• o    Others have just stopped saving.  Many feel that they might as well spend the money on things they can enjoy right now like trips and vehicles.  They think they will start saving again when rates start to increase.
• o    These 2 behaviours mentioned above are a concern to the Bank of Canada and economists everywhere because they go against the conventional advice for investors.

Just a quick comparison for some trends:

                 Avg 5 year mortg       Avg 5 Fixed GIC       Avg Inflation     
1980                 14.5%                      11.0%                   12.0%     
1990                 13.0%                      10.0%                     5.0%     
2000                   8.3%                       5.1%                      3.2%     
2010                   4.1%                       3.0%                      2.0%    

These warnings from Bank of Canada are meant to encourage consumers to behave fiscally responsible in order to have a stable, growing economy.  From a more personal level, we here at Rocky Credit Union encourage fiscal restraint so that you can enjoy your savings in your retirement and enjoy not having a heavy burden of debt throughout your working life.

As you look at your investments and debt payments, always keep in mind that it isn't just today's rate you should be thinking about, but what will happen tomorrow too. Inflation can eat up a lot of your investments if you haven't planned for it.  Visit a Financial Planner if you need help figuring out what will work best for you.  You can also use a variety of online calculators to figure out your investment needs for yourself.  Jerry