Locking in interest rates: What you need to know

When I speak about the outlook for agricultural markets people often ask me, “Is the Bank of Canada (BoC) going to cut its key policy rate? And when should I lock in my rates”?

The first question is easier to answer.

Will the BoC cut its key policy rate?

The market estimates nearly a 40% probability that the BoC will cut its overnight rate before the end of May. Pretty strong odds. If the BoC cuts its overnight rate, borrowing costs for businesses should decrease.  

When’s the best time to lock in interest rates?

The answer to this question is more complex. Interest rates charged to businesses are based on a combination of factors: short-term versus long-term, risk, etc. The type of loan influences the patterns in interest rates:

  1. Variable rate products are primarily set based on the prime rate, which tends to follow the movement in the BoC’s overnight rate. But as 2015 illustrated, a cut of the overnight rate doesn’t necessarily mean a proportional cut in the prime rate. The outlook for the economy also impacts the “discount” or “premium” charged relative to the prime rate
  2. Fixed rate products are primarily set based on the bond market. The price of bonds evolve according to the outlook for the economy in Canada, but also elsewhere such as in the U.S.  Therefore, the BoC has an influence on fixed rates, but no real control over them.

The chart below shows patterns in the 10-year Government of Canada bond and the BoC’s overnight rate. These patterns demonstrate the impact of market conditions on interest rates. Consumer debt levels, unemployment, housing and other similar economic factors all impact the overall risk in the economy and borrowing conditions.

What does this mean for businesses?

Ultimately, the decision between a locked-in or a floating rate is an individual choice and needs to match the long-term strategic plan of the business.

The bottom line?  Don’t rely solely on announcements from the BoC. Keep your eye on broader bond markets to successfully plan your business’ financial future.