There has been alot of talk in the last year about the housing market. And if you're like me, you have heard that the interest rates play a big role not only in the real estate industry, but the economy and Canada's presence on the world stage.
But why? Why does it matter than we have seen increases of overnight rates set by the Bank of Canada (BOC) rise over 75 base points since this time last year? is the effect of the rising interest rate all negative for the consumer? How will these changes affect me in the next 5 years?
I hope I can help in breaking down this information for you to help you better understand this issue and how you mitigate your risk with the change.
So, lets start. What is interest? It is the cost of borrowing money which needs to be repaid when a loan is provided. There are two types of rates, variable (change over the course of a loan) and fixed (set the same for the duration of the loan). Variable loans are subject to changes in the overnight rate changes. When the overnight rate from the BOC increases, the cost of borrowing funds increases for the lenders, which ultimately pass the increase to the consumer. This works the opposite way when the overnight rates decrease.
With respect to the consumer, this increase or decrease changes the amount of purchaisng power they have when qualifying for loans and the amount they can receive. As well, it changes where they prioritize what needs to be paid from their household budgets (i.e. the car loan cost is increasing, the entertainment amount will need to be reduced)
By now you are thinking, why would the BOC increase the rates if it hinders my ability to buy goods and services to grow the economy? Well lets look at what other ways the interest rates become important.
Inflation is where the price of goods and services increase over time. When the economy is peforming well, growing more and more people are spending, one of the natural by products is inflation. As demand increases, supply becomes less causing price to increase. The interest rate is used to slow the inflation rate by reducing the purchasing power of the consumer to ultimately reduce the amount of demand for goods ans services, ultimately easing pressure on price. For most consumers, this is a good thing in that with the lower prices, the value of each dollar can purchase more.
The other factor impacted by the interest rates is the Canadian dollar and its foreign exchange. When the interest rates increases, the dollar increases, allowing more purchasing power for us on the world stage (yes! shopping in the States doesn't burn the wallet!). When this happens local goods and services become less favourable. This is another way for the BOC to direct consumers to buy foreign in an attempt to ease pricing contraints on local markets. If the cost fo doing business is too high in Canada, the higher exchange helps to allow consumers to ease demand locally and spend internationally.
With the Canadian economony growth on par with forecasts (see below), the BOC has used the interest rates to ensure they are able to manage the foreign exchange and inflation issues we face.
In 5 years, particularly with the introduction of the stress test, th BOC has positioned themselves to readily act when any changes in the Canadian or world economy surface. The growth of the economy is good, increased foreign exchange leverage is good, but to what extent for the consumers and businesses in Canada? As the Canadian economy grows you will continue to see increases in the rates to help manage the consumers needs. The interest rates are essential to ensure the Canadian economy is at pace with what the consumer needs.
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