A potential 0.25 per cent hike in the Bank of Canada’s benchmark interest rate later this week might not prove to be a massive factor in economic output and household finances, but a business journalist argued that such a move would almost certainly herald an end to the long afternoon of cheap debt that Canadians have been enjoying for some time now.
The increase in the household debt-to-income ratio “has been driven by historically low interest rates,” industry observer Joe Castaldo wrote recently in a piece for Maclean’s.
“Naturally, an uptick in the cost of borrowing should dissuade Canadians from taking on debt at such a fast pace. There are already signs the debt-to-income ratio has peaked (it ever-so-slightly decreased in the last quarter, for example) and a rate hike could cause it to slow further or flatline,” Castaldo added. “Anything to prevent Canadians from becoming even more indebted should be a good thing.”
As to fears that the economy would suffer from households limiting their expenses due to higher interest rates, Castaldo cited TD Bank figures showing that GDP is trending at a robust annual growth of 3.7 per cent.
“The only reason the Bank of Canada would even entertain raising interest rates at this point is because the economy is strong enough to sustain it,” Castaldo quoted TD Bank Financial Group chief economist Beata Caranci as saying.
The flip side, of course, is that households will be allocating more of their incomes to servicing debts.
“The Parliamentary Budget Office recently estimated the debt service ratio will increase to more than 16 per cent over the next few years, warning that the ‘financial vulnerability of the average Canadian household would rise to levels beyond historical experience.’ It’s an open question how some Canadians will cope with higher payments.”
“If Canadians are paying more to service debt, they’ll also have less money to spend, which could weigh on the economy,” Castaldo explained. “That’s part of the reason why economists anticipate the Bank of Canada will tighten gradually and allow households time to adjust.”
Most importantly, the national housing market might enter a period of slowdown as a consequence of a BoC rate hike.
“Falling rates have been an important driver of the residential real estate market, since buyers can take on bigger mortgages. Higher carrying costs reverse that trend,” Castaldo wrote. “[First-time] buyers play a much bigger role in the rest of Canada, and they’re more sensitive to interest rates.”
MBN
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