What the Bank of Canada’s interest rate hike means for Calgary business

Posted by: Kaitlyn Mason on July 26, 2017

This week our Economic Policy Analyst, Franco Terrazzano, explores what the Bank of Canada's recently hiked interest rate means for Calgary business activity and the economy.

On July 12, 2017, the Bank of Canada increased its benchmark interest rate for the first time since 2010, raising it from 0.5% to 0.75% (a “25 basis point increase”). With this decision, Canada becomes the first G7 nation to join the United States in hiking interest rates.

The higher interest rate has raised many important questions for Calgary’s business community around what it may mean for business activity and the economy. Let’s take a closer look.

What does the Bank of Canada’s decision tell us about the national economy?

In recent years, the Bank of Canada has moved interest rates in accordance with Canada’s economic well-being; interest rate hikes when the economy is booming, and a falling rate during times of economic hardship and lower consumer spending.

For example, during the Great Recession, the benchmark rate was lowered to 0.25% to encourage more borrowing and greater spending. Since then, the Bank of Canada increased interest rates as our economy recovered in 2010, and lowered them once again in 2015 to shield against the falling price of oil.

Perhaps more important than the 25 basis point increase, however, is what the hike itself “signals”.

The decision to increase the interest rate by 25 basis points reflects the Bank of Canada’s confidence – due to strong consumer spending and exports, higher price of oil, and rising employment – that the national economy is emerging from a low point. The Bank estimates that real GDP growth will continue in the future, from 2.8% in 2017, to 2% in 2018, and 1.6% growth in 2019.  

More rate hikes are likely on the horizon. Bank of Canada officials are indicating that they plan to raise interest rates by at least 50 basis points (up to 1%).  

What do higher interest rates mean for business activity?

When interest rates rise, businesses are often worried about two important issues:

1. Increased cost of capital, reduced investments, and lower economic growth 

While the cost of borrowing will increase, access to relatively affordable capital will also likely be on the rise. An important aspect to remember about borrowing and lending is that as the interest rate rises, more lenders are willing to provide riskier credit. This may improve small business’ access to much-needed capital. 

Even with the increase in interest rates, total investments across Canada may not be negatively impacted.

Why? Investments may increase to take advantage of the relatively low interest rates (remember further hikes are likely to follow), and the strong consumer spending forecasted by the Bank of Canada. Based on that, the interest rate hike is unlikely to cause serious harm to our economy.  

2. Rise in the value of the dollar and reduced global competitiveness  

Another concern among businesses is that higher interest rates may increase the value of the loonie.

Here’s the rationale: when Canada’s interest rates rise compared to another jurisdiction, it becomes relatively more profitable to deposit money in Canada. An increased interest rate tends to increase the value of the dollar (holding all else constant). In fact, we have seen the loonie appreciate relative to the U.S. dollar since the Bank of Canada increased rates.

An interest rate hike resulting in a stroner loonie, may make life marginally more difficult for some exporters.

However, Calgary businesses should not be overly concerned just yet. While the Bank of Canada’s monetary policy does influence our exchange rates, so do many other macroeconomic factors.

As time passes, other factors may further appreciate the loonie, or act to depreciate its value. In today’s highly globalized economy, many businesses may also benefit as imported inputs become relatively less expensive. 

The appreciated loonie (at least in the short run) and greater debt payments may negatively impact the oil industry, specifically because Alberta’s producers sell their product in U.S. dollars and pay their expenses in Canadian dollars. That said, the success of Alberta’s oil industry depends on many other global variables such as the price of oil, and access to markets. 

What does it all mean?

Each business faces its own unique unique situation, which means that changes in the interest rate and exchange rate may impact each one differently.

However, this relatively small interest rate jump should not be a serious cause for panic.  

Perhaps more important than the actual hike in the interest rate, is the Bank of Canada’s increased confidence in the broader Canadian and global economy. With growth forecasted to continue, the Canadian economy does not appear to need artificial stimulus through low interest rates.

Franco Terrazzano is an Economic Policy Analyst at the Calgary Chamber.