Interest rates are top of mind for economists both north and south of the border – while Canada has taken a “cut and leave em'” approach amid lower oil prices, it’s a different story in the U.S.; as economic growth improves there, it has been strongly expected that the U.S. Federal Reserve will raise central rates sometime in 2015. Doing so would have deep implications for Canada, which traditionally follows U.S. monetary policy.
While initial speculation had timed a U.S. rate “liftoff” in June, new signs that the U.S. economy is struggling to rebound could mean Fed Chairperson Janet Yellen may have to put the brakes on her plan to hike rates. When it does happen, it will be the first hike by the Fed Reserve in more than a decade. As the global economy takes many of its cues from U.S. interest rates, it’s crucial that any change be made with utmost caution, as markets could react with volatility.
Canada is Watching
Despite the Bank of Canada’s surprise January rate cut, our central bank is still very much looking to our American neighbours for guidance. A rate hike in the U.S. would almost certainly mean a rate hike here. The Bank would be forced to walk in step with the U.S. in order for its interest rates to remain competitive to investors. As bond markets and rates remain low, and other debt instruments struggle, keeping our rates low while the U.S. raises theirs would mean even less interest from investors in those markets.
The Fed’s Next Move
Even just alluding to a potential rate rise is enough to throw markets into a tizzy. Last week, Yellen signaled in a speech that, despite the setbacks to economic recovery, the U.S. central bank is indeed on track to raise rates this year, though much later than initially expected. Some analysts believe the recent weak data could force the Fed to wait longer before starting its first tightening cycle.
Brace for Volatility
Whether it happens this year or in early 2016, global markets can expect some volatility when the U.S. raises rates. In a trip to Israel last week, U.S. Federal Reserve Vice Chairman Stanley Fischer said, “In the normalizing of its policy, just as when loosening policy, the Federal Reserve will take account of how its actions affect the global economy.” He adds, “The actual raising of policy rates could trigger further bouts of volatility, but my best estimate is that the normalization of our policy should prove manageable for the emerging market economies.”
The Impact To Canadian Mortgages
If the Bank of Canada raises the Overnight Lending Rate, in any circumstance, homeowners will be the first to feel it. Those in a variable or floating rate mortgage will see an immediate bump. As Canada’s banks did not match the Bank of Canada’s Overnight Lending Rate cut in January (Prime was slashed only 15 basis points to 2.85 per cent instead of the full 25), there is a chance a U.S. hike would only push lenders to catch up to their pre-cut levels (a full 3 per cent).
Homeowners would be wise to start taking advantage of low rates now. Every dollar extra you put into your mortgage goes straight towards principal. Pay extra now rather than waiting and paying a premium to the bank when they raise their rates.