A new survey by Forum Research shows that Canadians are becoming increasingly worried about rising interest rates and the negative impact they could have on their finances.
For over nine years, interest rates have been held at record lows in an attempt to stimulate business growth, discretionary spending, and the purchase of personal residences.
Recently, however, it looks like the faucet that’s been pouring out nearly free money is beginning to tighten. On September 6, the Bank of Canada once again raised its benchmark overnight rate from 0.75 to 1 percent. This makes it the second rate increase in three months.
By historical standards rate hikes this tedious and cautious would considered a joke, but for more and more Canadians it’s no laughing matter. With surging personal debt, stagnant wages, vanishing disposable income, and economic uncertainty, the prospect of continued rate hikes could prove financially crippling for those who have grown accustomed to nearly a decade of record low rates.
Here are some of the key findings from the survey:
- 51% say they are somewhat concerned about the recent rate increase
- 40% say the rate increase will have a negative impact on their financial situation
- 26% said they had no emergency savings
- 13% said they had savings of six months to a year
- 35% of those aged 34 and younger were the most likely to say they had no emergency savings
- 48% of those aged 35-44 were the most likely to say the rate increase would negatively affect their financial situation
While rates are nowhere near where they were in the 1980s, there is growing concern about how the economy will thrive if interest rates rise to the level of their historical norms.
An industry that is highly sensitive to interest rate hikes is real estate (which makes up about 12% of GDP). If rates were to climb too high, the housing market could take a nose-dive, drivers buyers out and forcing sellers to liquidate their homes at grossly discounted prices or be forced to contend with “underwater” mortgages (a mortgage where the balance of the mortgage is higher than the market value price of the property). What will follow, of course, is a significant contraction in discretionary spending, which will send the economy into a deflationary spiral (very difficult to avoid in an economy that is primarily driven by consumer spending).
As for the business world, fewer projects will become economically viable if rates continue to rise. Almost every business startup or investment in capital expenditures looks like a winner when the cost of capital is low. Not so when rates increase. Many projects will be purged from the market as they will be unable to generate a return required by investors and lenders in a high-interest rate environment.
Canadians, on average, now owe about $1.67 for every dollar of income – the last thing they need is a surge in interest payment on their mortgages. We could see huge waves of insolvencies in the near future if the Bank of Canada misplays its hand (Goldman Sachs has pegged the chances of a housing collapse at 30%). If the housing market crashes the rest of the economy could follow.
It does seem that mountainous debt levels, asset bubbles, and a perpetual fear of slight upticks in interest rates may be the new normal in Canada (and the West in general). How long an economy with these characteristics will be sustainable is anybody’s guess.
Let’s wait and watch the interest rate slowly tick upward – and hope for a soft landing if things go south.