UPDATE: On Wednesday, the Bank of Canada raised its key interest rate 25 basis points, as the markets had largely anticipated. The Bank will continue to assess the evolution of the Canadian economy and inflation to determine future adjustments to interest rates. While borrowing costs remain historically low, the Banks’s decision offers a good time to pause and analyze your financial strategies, especially as it relates to fixed vs. variable rates.
After nearly seven years of low interest rates, officials from thehinted that the time of a rate hike is near. In fact, it could happen as early as July 12, 2017. The odds of an interest rate increase in July are currently approaching 80%. No matter what happens at the July 2017 announcement, borrowing costs should be expected to climb in the second half of 2017.
Three factors behind the possibility of seeing rates trend up
1. Inflation expected to increase in next 18 months
Current inflation is low at 1.3%, and at the lower end of the BofC target of 2%. This is one of the reasons why the BoC could wait before lifting its key interest rate. Inflation forecasts to be released Wednesday will say a lot about the future paths of interest rates. Higher projected inflation would mean higher rates.
2. Economy has largely recovered from low oil prices
While crude oil prices remain low, the Canadian economy definitely made adjustments to this new reality. The 2015 rate cuts helped remove some excess capacity in the economy. But unemployment has now declined and business investment rebounded.
3. Economic growth expected to improve
Canadian GDP growth has been strong and it is expected the BoC will reaffirm its positive forecasts of last April when it stated that economy would grow by 2.5% in 2017 and near 2% in 2018. I expect the BofC will raise growth projections for 2017 and 2018.
What does this mean for the loonie?
The Canadian dollar has averaged US$0.749 in the first half of 2017. We expect the dollar will average slightly above US$0.75 for the remainder of the year. The loonie’s recent appreciation is the result of market anticipation that a rate hike will be occurring, with the loonie increasing to its 2017 high above US$0.771.
Borrowing costs should climb in the second half of 2017
Messages to the effect that economic conditions warrant higher interest rates in the near future have already lifted interest rates in financial markets. This is likely to translate into slightly higher borrowing costs, trending up at a relatively slow pace however. Check out our Farm Financial Fitness post on how a rise in interest rates impact your debt service ratio.