Review your financial strategy now with trusted advisors, says chief economist

Producers should meet with their financial advisors to discuss the Bank of Canada’s latest interest rate activity and make sure their financial strategy is tested against multiple scenarios and up to date, says FCC’s chief economist.

The central bank increased its rate Wednesday by one-quarter point, to 1.0 per cent. That's the second 25-basis-point increase since July.

The bank says employment and wage growth sparked strong consumer spending. As well, business investment and exports also improved.

Think strategically

For J.P. Gervais, FCC's chief economist, the hike means now is the time to think about financial strategy. Thoroughly understanding risk is key when interest rates are in flux, he says.

“Knowing what this modest increase could mean is important for considering strategies such as switching from a floating rate to a fixed rate, if you and your advisor think that’s a timely move,” he says.

According to Gervais, income is the primary driver of debt repayment. Fluctuations in commodity prices and interest rates will affect producers’ ability to pay back that debt.

Understand farm financial risk

So he’s urging producers to understand exactly how much risk they’re taking on, and what flexibility they have in facing higher interest rates or a lower income. That’s called financial “stress testing.”

Says Gervais: “Work with your advisor to look at various scenarios, and your capacity to repay your debt. It’s the best approach to take.”

Gervais says current financial ratios for Canadian agriculture are in line with historical averages. And farm income was at record levels in 2016.

Strong Canadian ag

To him, those factors mean Canadian agriculture is strong and well-positioned to withstand small interest rate increases, which the industry has been expecting after an extended lull. Interest rates and the Canadian dollar are likely to continue to rise in the short term. Whether it’s a pattern that will continue is too early to say.

But Gervais believes the Bank of Canada would like to get back to 2015 rates, when it cut its rate twice in response to the Canadian oil sector slowdown.

But, he adds, only if interest rates climb over the two to three years can we expect this to be a signal of a long-term upward trend.

The art of setting interest rates

“The Bank of Canada always looks beyond the immediate horizon,” he says. “That’s why setting interest rates is more of an art than a science. The Bank relies on complex, long-term information that is often imprecise, so it’s not unusual for it to revise or update its projection and chart a new course. That’s what makes accurately predicting interest rates impossible.”

He’s also keeping his eye on the value of the Canadian dollar versus the U.S. dollar. He says that a move of the dollar above 85 cents would challenge profitability for some operations.

“A lower loonie gave us better commodity prices and makes the demand stronger for what we sell in foreign markets,” he says. “You can always find some cases that would benefit from a higher dollar, but in general our customers are better off in a lower-dollar environment.”

Bottom line

Overall, Gervais says when interest rates are in flux, producers need to optimize their financial strategies and understand their financial risks. The best way to accomplish this is by meeting with their financial advisor.

Article by: Owen Roberts