NORTHERN INTEREST
With an economy closely tied to our southern neighbours, a rise in U.S. interest ripples
U.S. Federal Reserve’s impending rate hike has ripple effect in Canada,
When the U.S. Federal Reserve moves its benchmark interest rates, Canadians feel the reverberations in more ways than one.
Though not a sure bet, a U.S. interest rate hike this week — the first in nearly seven years — would signal the world’s largest economy is back in business
That would be good news for Canada, helping drive higher exports, economists said.
Economists and investors are split on whether a U.S. rate increase is in the cards when the Federal Market Open Committee concludes its regular meeting on Thursday. The benchmark Fed funds rate has been at 0.25 per cent since December 2008. “The U.S. economy is strong enough to allow them to step away from emergency low interest rate levels,” said Jennifer Lee, senior economist with BMO Capital Markets.
On the other hand, “given the weakness in emerging markets, it wouldn’t come as a complete shock if they decided to hang back a little bit.”
The U.S. unemployment rate has fallen to 5.1 per cent, new home construction and auto sales are up. And years of years of record low interest rates — designed to prop up the economy after the financial crisis of 2008 — has left some assets overinflated, such as U.S. stocks and commercial real estate.
On the other hand, with growth in China’s economy slowing, some observers fear a series of rate hikes could prematurely stall the U.S. economy’s recovery.
Another reason not to rush is the U.S. inflation rate, which is running nowhere near the Fed’s target of 2 per cent as the impact of lower oil and a higher U.S. dollar puts downward pressure on prices.
“At this point, it looks like the odds (of a rate hike) are slightly less than even,” said Michael Dolega, senior economist at TD Bank, adding the Fed could do something creative such as start a rate hiking cycle but maintain a very slow pace.
“They could say this is the first and there’s probably not going to be another one for some time.”
U.S. Federal Reserve Board chair Janet Yellen previously hinted at such a strategy during Senate testimony, he noted. What would a U.S. rate hike mean for Canada? The Canadian dollar will likely fall. Why? Higher U.S. rates make U.S. investments more attractive, thus boosting the value of the U.S. dollar relative to other currencies, including Canada’s, which is currently at 75.39 cents (U.S.) Canadian interest rates: will likely stay the same. The Bank of Canada usually raises its trendsetting rate in tandem with the U.S. Fed, partly because the two economies are so closely tied. But Canada’s resource-dependent economy has been hit hard by plunging oil prices, leading to further rate cuts here and delaying future increases. The Bank of Canada benchmark interest rate is 0.5 per cent right now. Five-year mortgage rates: will likely rise. Longer term loans, such as five-year fixed rate mortgages, are influenced by bond rates. That’s because the commercial banks raise money from bonds to finance long-term mortgages.
When the U.S. Fed raises its trendsetting rate, the bond market also rises. Canadian bond prices tend to rise and fall in tandem with U.S. rates.
Canadian five-year mortgage rates are at 2.6 per cent (average at major banks) Canada’s exports to the U.S.: will likely rise. A lower Canadian dollar makes Canada’s products and services cheaper to buy in the U.S. That will be a boon to the Canadian economy, though the link is not quite as tight as it was in the late 1990s when Canada began losing its competitive edge in manufacturing.
Where are Canada’s exports now? Exports grew 2.3 per cent pace, or $1 billion, in July, to $45.5 billion. The stock market: Uncertain. Stock markets have flourished on low rates as investors looked to equities for better rates of return. Talk of rising U.S. interest rates has already taken some of the shine off U.S. markets while plunging oil prices have taken the steam out of Canada’s stock exchange.