What the interest-rate hike means

On Wednesday, the Bank of Canada raised interest rates for the first time in nearly seven years.

Canada’s key lending rate was increased by a quarter of a percentage point to 0.75 per cent.

While this rate increase was largely expected and came as no real surprise to anyone, the shift in monetary policy marks a significant change in our economic landscape.

Bank Governor Stephen Poloz stated Wednesday we have “turned the corner” and “we have the economy in a place where there’s finally a two-sided risk to the outlook – as opposed to just being concerned about downside risks.”

While these statements are more upbeat than previous commentary, it is important to note the downside risks to our economy are still very real and present and this rate increase is not being done due to an abundance of strong data.

So, what does this rate increase mean for you and what aspects of your financial plan should you be looking at?

The Canadian dollar has been climbing for a couple of weeks now in anticipation of the rate hike and in early trading Wednesday, it was up another 1.5 per cent against the U.S. dollar.

The loonie is up roughly five per cent against the U.S. so far this year.

The U.S. has been raising rates for a while though now and its economy is certainly in far better shape than ours, so don’t expect this trend to continue.

While nobody has a crystal ball and there are too many variables to say for sure, this might be a good time to pick up some U.S. currency if you plan to spend your winter down south.

I still think the loonie at 70 cents U.S. is a realistic valuation.

The single-biggest impact to many Canadians is any debt with a floating interest rate.

Floating or variable interest rate loans such as mortgages are based on the bank’s prime rate.

All major banks in Canada have had their prime rates set at 2.7 per cent for some time now.

The last time the Bank of Canada cut its rate by 0.25 per cent, the banks bucked the historical trend of following suit and only lowered prime by 0.15 per cent.

There was some speculation a 0.25 per cent rate increase might see a prime increase of only 0.15 per cent, but that is already proving to be unlikely.

Royal Bank was quick out of the gate Wednesday morning to boost their prime rate by the full 0.25 per cent to 2.95 per cent effective Thursday.

By the time this article goes to print, I’m guessing all of the others will happily follow suit.

A 0.25 per cent rate increase may not sound like much, but consider what that means for a $500,000 mortgage.

This small rate increase will have the mortgagee paying an extra $1,250 per year in interest.

The bigger issue here is what will happen with additional rate increases?

The same homeowner would be looking at an extra $5,000 per year or $417 every month if rates go up by another 0.75 per cent.

There are far too many people living paycheque to paycheque in homes they really can’t afford.

The shift to an increasing interest rate environment could cause some serious problems.

You should also take a moment to consider how rising rates will affect your investment portfolio.

Canadian bonds have been hit pretty hard over the past month while senior secured (floating) loans have held up quite well.

Is your fixed-income portfolio prepared for this new state of affairs?

There is a common consensus the Bank of Canada will hike rates again before the end of the year.

While rate increases will help boost earnings for banks and insurance companies, the impact on the consumer can be significant and the Bank of Canada will hopefully take a pause after two increases to let everything settle.

In the meantime, it’s important to consider what a rising interest rate environment means for you and what you can do to prepare for it.