In response to the recent sharp drop in oil prices, the Bank of Canada surprised markets this week by cutting its overnight lending rate from 1% to 0.75%.
Here are three ways it’s likely to affect consumers:
1. Impact on investments
As the big banks base their prime rate on the Bank of Canada key lending rate, the rate cut is bad news for those relying on investment income from interest-based savings accounts and GICs. In the case of bonds, the domestic market reacted immediately as yields slumped/prices rose. Sadiq Adatia, Chief Investment Officer of Sun Life Global Investments, says, “We’ve been more bullish on Canadian bonds versus their global peers in recent months and this policy action reinforces that stance.” While he predicts, “Canadian equities are now even more likely to suffer this year on the possibility that economic risks will be realized,” he notes, “the drop in the loonie prompted by the rate cut should boost the value of investments denominated in U.S. dollars and other foreign currencies.”
For consumers, this underscores the need to have a diversified portfolio of investments along with a long-term financial plan. Because investments within various asset classes behave differently based on differences in the market, it’s important to have a mix of investments appropriate to your risk tolerance, time horizon, and financial goals.
2. Mortgage rates and lines of credit
A lower Bank of Canada rate is likely to lead to a similar drop in variable rate mortgages, lines of credit and floating-rate loans. Holders of fixed-rate mortgages, however, won’t see a drop in their monthly payments.
For consumers, this may lead to the temptation to borrow more, take on a larger mortgage or consider the availability of lower-cost credit as good reason for jumping into the current over-heated housing market. But while the rate cut may make carrying debt more affordable in the short term, it’s important to consider the potential long-term impact of a future rise in interest rates or drop in housing prices. Those who take on too much debt could find a future spike in rates could leave them unable to afford their monthly credit card fees or mortgage payments. Plus, a drop in housing prices could leave home buyers in a situation where the value of their mortgage is higher than the value of their home. Rather than taking on more debt, now is a good time to instead take advantage of the low rates to pay down debt.
3. Canadian dollar
The Bank of Canada rate cut caused the value of the Canadian dollar to fall sharply to $0.81 US (as of Jan. 22). Combined with the current drop in oil prices and its negative effect on the Canadian economy, predictions are the loonie may remain depressed for some time.
For consumers, this means Canadians will have less purchasing power abroad, something that will impact snowbirds and those with travel plans outside the country. The solution? This may be a good year to consider staying home and planning a vacation within Canada.