The Bank of Canada says this:
“Higher commercial interest rates mean people and businesses pay higher interest on loans and mortgages. This discourages them from borrowing and spending and puts the brakes on the economy and inflation.”
The Bank of Canada is always ‘up first’ and Canada’s big banks are quick to hike their prime rates following its moves.
BACK UP to when it all started – during the pandemic, when interest rates were cut to near zero. It was always just a matter of time that central banks would look to normalize once the global economy was back on its feet.
Interest rates have been relatively steady for a decade, and few entrepreneurs actively remember the high inflation and interest rates of the late 1980s and early 1990s. So it’s important to not panic. The economy has withstood––and can withstand––interest rate changes and inflation.
One year ago on March 2, 2022 – the day the Bank of Canada first embarked on the current rate-hiking cycle – RBC’s prime rate then stood at 2.45%.
- Prior to COVID-19, the prime rate had been 3.95%.
- During normal economic times, the BoC typically increases its benchmark rate in increments of no more than 0.25%.
- Prior to its April 2022 rate announcement, the Bank hadn’t raised the overnight rate by more than 0.25% in one shot since May 2000—more than 20 years ago.
Looking to combat persistent inflation by raising interest rates at a faster pace and to a higher level than forecasts predicted:
- The Central bank had hiked its benchmark rate, also known as its policy interest rate or overnight rate, by a quarter of percentage point (25 basis point), bringing it to 4.5% on Jan. 25, 2023.
- This caused Canadian prime rates to increase to 6.7% and all the other banks followed suit.
- The last time the prime rate was this high was in the first half of 2001.
- The Bank expects the inflation to reach 3% by the middle of 2023 and 2% in 2024. Thus BoC is done raising rates for the time being. There seems to be a light at the end of the tunnel!
The BoC aims to keep inflation stable at 2%—or within the target range of 1% to 3% per year. That’s where the overnight rate comes into play: It’s the BoC’s primary tool for achieving its inflation target. The overnight rate influences how the banks will set their own rates. It acts as a sort of barometer for the rate at which major banks borrow and lend among themselves.
When the BoC raises the overnight rate, it becomes more expensive for banks to borrow money, and those costs get passed on to borrowers through higher interest rates.
“In Canada, recent economic growth has been stronger than expected and the economy remains in excess demand,” the Bank of Canada wrote in its January 2023 policy interest rate announcement. “Labour markets are still tight: the unemployment rate is near historic lows and businesses are reporting ongoing difficulty finding workers. However, there is growing evidence that restrictive monetary policy is slowing activity, especially household spending.”
Inflation, as measured by the Consumer Price Index (CPI) is a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money. Gradual inflation over time helps keep the economy strong by making increases in wages and expenses predictable for businesses and consumers. But inflation that exceeds the norm makes it more difficult for people to afford everyday expenses.
Gradual inflation is not a bad thing. But when the inflation needle spikes too quickly and hits some insidiously-predetermined “Red Zone”, the “Powers that Be” also hit “TILT” and open the “Emergency Inflation Booklet” for tools to get inflation back under control. (This is tongue-in-cheek, but the outcome is the same).
TOOL #1 – The Government COULD reduce its spending (particularly on direct cash programs) OR…
TOOL # 2 – The Bank of Canada can adjust its benchmark interest rate.
BINGO! Their “choose their own adventure” decision is so easy. Raise interest rates.
In short, the Bank of Canada hopes that raising interest rates will make people think twice before spending. This will lower demand and, in turn, lower inflation driven by excess demand.
Are Business just supposed to suck it up? Well, yes. And No.
There are things businesses can do to help them get through it. (Read “How to prime your business for higher interest rates”)
If you need help to find solutions to the effects high interest rates are having on your personal or business finances, don’t feel you need to do it alone. For financing options that can help reduce the cost of borrowing, call us at 905-686-8787 or drop us a line.
