The Bank of Canada (BoC) raised its overnight interest rate to 1.75% Wednesday. This is the BoC’s third hike of 2018, and the first since negotiations of NAFTA, now known as the United States-Mexico-Canada-Agreement (USMCA), finally came to a close this month following a lengthy period of uncertainty.
Canada’s central bank kept its overnight rate unchanged during its last rate announcement in September despite a strong national economy and low unemployment rates, which are typically grounds to justify a rate hike. Experts had widely cited uncertainty about the future of NAFTA, which was still being negotiated at the time, as a likely reason why the bank was reluctant to make a move.
“The global economic outlook remains solid,” the bank said in Wednesday’s announcement. “The new US-Mexico-Canada Agreement will reduce trade policy uncertainty in North America, which has been an important curb on business confidence and investment.”
Why the bank hiked today
The biggest reason is that the domestic economy is looking solid. The BoC notes that the finalization of the USMCA, coupled with a recently approved liquid natural gas project in British Columbia, has boosted corporate confidence — both business investments and exports are expected to grow in the coming months.
In addition, income growth is steady — a development that has worked with higher interest rates to push household spending up at what the BoC considers a “healthy” pace. Credit growth has meanwhile started to moderate, while housing activity across the country is finally stabilizing. Wage growth is fairly even, but is expected to pick up in the coming quarters.
Inflation dropped to 2.2% in September, bringing it closer to the sweet spot of 2% that the BoC advocates. It is expected to stay close to the 2% target through the end of 2020.
The BoC is tasked with keeping Canada’s inflation rates in check by adjusting its overnight rate based on the strength of the national economy. When the economy is flourishing, the bank increases rates to discourage reckless spending. When the economy is doing poorly, the BoC lowers its overnight rate to encourage consumers to spend and put more money into circulation.
How does this affect consumers?
To answer this, it’s first critical to understand the impact that the BoC has on the country’s consumer banks.
The BoC lends money to consumer banks (e.g., banks like BMO, CIBC, or Scotiabank that count businesses and average people as their clients), and its overnight rate is the interest rate that it charges. When that rate increases, and it becomes more expensive for banks to borrow money for themselves, they will almost inevitably try to compensate for these losses by raising their own interest rates for consumers. This impacts a variety of consumer loans that have floating rates, like variable mortgages or lines of credit.
Let’s say you have a $500,000 house, and a variable-rate mortgage. If your current variable mortgage rate is 2.44%, your monthly payment will be $2,198. Add another 25 basis points, and your rate will shoot up to 2.69%. That raises your monthly payments to $2,260 — a $62 monthly increase, or a $744 annual increase.