When the Bank of Canada meets on July 11, it should, and probably will, raise interest rates. Yes, hiking rates for the fourth time since last July means it will become more expensive to hold debt (of which Canadians have plenty). Household consumption will continue to slow, and delinquencies could tick higher. But after 10 years of ultralow rates, Canada is robust enough to weather the storm. Inflation is on target near 2 per cent, the economy is stable, unemployment is near a 40-year low, and strong U.S. and global growth are providing additional support.
There are many who say now is not the right time for another hike. After all, the country is facing heightened trade policy uncertainty, falling house prices in some big cities and elevated debt levels. These are reasonable concerns – but they have to be weighed against the risks associated with keeping rates on hold.
Can the central bank hike with so much uncertainty around trade policy? Yes, or it could be waiting for a long time. Governor Stephen Poloz has repeatedly said that the BoC does not incorporate hypothetical scenarios into its policy decisions, and most of the trade narrative so far has involved a very wide range of hypothetical outcomes. If there were a firm “end date” on trade uncertainty, it could make sense for the BoC to wait. But we might not get a resolution on trade discussions until well into 2019.
For example, Section 232 studies to determine the effect of imports on national security – such as the one the United States is currently pursuing on the subject of auto tariffs – typically take 270 days. The U.S. midterm elections in November may or may not provide more clarity. The BoC is certainly not ignoring the elephant in the room: Forecasts have been lowered to incorporate an assumed drag on growth from uncertainty, and the next set of forecasts is expected to include the impact of steel and aluminum tariffs. As of now, however, announced policy changes aren’t likely to be significant enough to change Canada’s positive economic narrative – particularly as businesses continue to be optimistic about future sales and investment.
Won’t more rate hikes hurt house prices, already down sharply in Toronto and Vancouver? They won’t help, but they will probably hurt less than most would think. Recent weakness in housing activity probably has more to do with regulatory changes implemented in January than changes in interest rates. Canada’s stock of mortgage debt remains somewhat shielded from rate hikes. Only a third of outstanding mortgages are of the variable-rate variety, and of those about 40 per cent have fixed payments. Plus, the BoC’s mandate has far less to do with home prices than it does with financial imbalances and risks.
If regulation is tackling the risky borrowing in housing (and it is, by the way, a far more precise tool than interest rates), the BoC can hike rates more confidently and should take the opportunity to do so.
Can Canadians absorb rate hikes with so much debt on their books? Data from the first quarter suggest they can, thanks in large part to record low unemployment and strong income growth. Indeed, the consumer debt service ratio, which measures the share of income spent on interest and principal debt payments, is marginally lower than it was. Meanwhile, the debt-to-income ratio has declined for two consecutive quarters, suggesting Canadians may be taking out less credit and paying off existing debt. That’s not a bad outcome at all.
The process of normalizing rates was always going to hurt consumers’ wallets – and like dieting, there’s never a perfect time to start. But it’s time we accept that higher rates are part of a healthy economic routine and get ready to tighten our belts – ever so slightly.
by Manulife Asset Management.
Read the original article at The Globe and Mail