What an Interest Rate Hike Means for Savings, Debts and Investments
The Bank of Canada raised the overnight rate again on October 24, 2018. This marks the fifth interest rate hike in just over a year.
For Canadians who feel like they're barely keeping their heads above water with their debt loads, rising interest rates bring added stress. But for almost everyone else, the hikes can be seen as good news.
Why?
Because the Bank of Canada has to have a certain degree of confidence that the economy is in good enough shape to weather the effects of a rate hike.
Taking a big step back for perspective, higher interest rates make it less attractive to borrow money, which has a dampening effect on spending. Spending is essentially what drives the economy. And if the powers that be have decided that the economy is strong enough to take this dampening in stride, that's a positive sign overall.
Let's take a quick inventory of how a rate hike affects different aspects of our financial lives:
Savings
As interest rates go up, financial institutions have more latitude to compete on the interest rates they offer on their savings accounts and GICs. The low interest rates we've seen for the last 10 years have been top-of-mind for seniors who haven't been fans of the low rates of return they've seen on their more conservative savings and investment portfolios. Expect a gradual increase in how much interest you earn on these deposit products.
Debts
You're going to start to feel more pinched if you're living on the edge with your debt load. Variable-rate debt, where the interest rate is tied to the prime rate, is going to impact you as soon as the financial institution raises its prime rate. Examples are lines of credit and variable rate mortgages. Fixed-rate debt, like credit cards and many auto loans, won't see much change immediately. But for fixed-rate mortgage holders, the pain will come upon renewal, especially if there have been multiple rate hikes since your current mortgage term started.
Investment Portfolios
Stock markets tend to respond well to interest rate cuts, and tend to respond poorly to interest rate hikes. This ties back to the impact of interest rates on the attractiveness of borrowing money for the purposes of spending. If rates are going up, which should lead to a dampening effect on spending, this is normally negative for markets. But again, if rate hikes are seen as a sign of confidence, this short-term negative impact may not materialize. Regardless, you shouldn't make any changes to a disciplined portfolio based on short-term events. A well-built portfolio is designed for the long term. Short-term events like this are like running over a mild pot-hole on the highway. You notice it when it happens, but ultimately it isn't taking you off course in any meaningful way, and soon you'll have forgotten all about it.
Should I Change My Game Plan?
No matter where interest rates are, you should be in control of your finances and not have it the other way around. If the thought of another four interest rate hikes drains the blood from your face, then you'll definitely want to change your game plan to focus on deleveraging yourself, because that's actually a possibility. ('Deleveraging' is just fancy talk for reducing your debt load.)
Otherwise, there's no need to panic. As far as things go from a financial history perspective, this is nothing really unusual.
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