Rising interest rates: What's your risk tolerance?
Producers should always know how sensitive their operation is to interest rate increases since it is reasonable to expect increased volatility and higher rates at some point in the future. Here’s what you need to know for your operation to make the right decision choosing between fixed or variable rate loans if higher interest rates are on the horizon.
BoC decisions drive variable rates
The prime lending rate is the annual interest rate Canada’s major banks and financial institutions use to set interest rates for variable loans. As the Bank of Canada increases the interest rate they charge lenders, known as the “overnight” rate, the prime lending rate and your variable rate will increase. Over the last decade, the prime rate has been consistently below 4% and saw relatively minor fluctuations.
Figure 1: Bank of Canada prime rate
Financial markets expect three BoC rate hikes of 25 basis points in 2022.
Fixed rates higher due to domestic and international bond markets
When there is a possibility the BoC will raise interest rates, you may choose to lock in rates on new, or existing, debt. While longer-term mortgages usually offer higher interest rates, locking in can avoid problems associated with a variable rate loan’s future rate increases. One advantage to fixed rate products is the predictability of your repayments for a set period. That’s important when revenues are flat and/or input costs increase.
Unlike variable rates, determining the rates for fixed-rate loans is complex, as they’re derived from many influences, global and domestic. The cost of a locked-in five-year mortgage reflects the lender’s costs to access funds in the bond market. Interest rates on a one- or five-year term vary. Within a growing economy, interest rates on short-term bonds are usually lower than rates on long-term bonds.
Borrowing costs could climb in 2022.Understanding your risk tolerance to rate increases is the first step to take. It also makes sense to monitor changes in the BoC rates and broader economic trends including inflation.
To learn more about fixed vs. variable interest rates, watch this Economics Business Essentials video.
Justin joined the FCC Economics team in 2021, specializing in monitoring agricultural production and analyzing global supply and demand trends. He grew up on a mixed farm in Saskatchewan and continues to be active in the family operation. Justin holds a Master of Applied Economics and Management from Cornell University and a Bachelor in Agribusiness from the University of Saskatchewan.