What is the policy interest rate?
The policy interest rate is the fixed interest rate set by a financial institution for a country or group of countries. This determines how much it will cost to borrow money from a central bank. In our case, the Bank of Canada is the one that is regulating, among other things, the country’s economic activity. Once the Bank of Canada sets the policy interest rate, other financial institutions use it to set the interest rate on a variety of loans (personal, mortgages, etc.) offered to clients. The current increase is an attempt to counteract inflation, which is rising in Canada and the US.
What is inflation?
Inflation is an overall increase in the average price of goods and services. When inflation is low and predictable, it means that the economy is doing well, and the overall value of money is stable. Long story short, it means you have more money in your pocket.
When inflation is too high, consumers, businesses and investors lose purchasing power. This means overall economic development suffers. When this happens, the Bank of Canada will usually step in with a policy interest rate hike to try and stabilize the economy.
How does an increase in the policy interest rate affect my finances?
Most people will be affected by a policy interest rate increase. This means that they’ll pay more interest on their loans. Households and businesses are more likely to reduce their expenses when this happens. Demand for goods and services is expected to decline and their prices may stabilize in the future:
- New homebuyers may have to pass a mortgage stress test at a higher rate. Currently, the mortgage stress test is at the higher of 5.25%, or the mortgage rate plus 2%.
- If you have a variable rate mortgage, your monthly payments will increase. Fixed rate mortgages will only be affected when you renew.
- This could be an opportunity to make new investments. While the market is down right now, it could be the right time to buy low on interesting stocks. Also, investments such as GIC’s or bonds see their interest rates rise in a period of rising rates.
- If your mortgage term expires in less than 6 months, an early renewal may be the key to helping you secure a lower rate before the next rate increase without penalty. If your term expires in more than 6 months, you’ll need to consider the penalty fee when making a decision on early renewal.
- While food, gas, and furniture cost more than this time last year, now’s the right time to readjust and evaluate your budget.
Policy interest rate hike: do I need to review my financial plans?
If there’s a policy interest rate hike, take some time to think about your current projects and future plans, and make informed decisions. You might save money by postponing a major project rather than tackling it now. Alternatively, now be the time to consolidate your debt and get your ducks in a row before rates increase further.