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  • KPB & Co Research


Canadians have become more indebted relative to their income almost every year for the last 48 years. Most of that debt has been used to finance consumer goods and homes. The increase in the debt has become more pronounced over the last 10 years, as low interest rates have made it cheaper to carry a larger debt pile. With the Central Bank of Canada increasing their target rate 5 times since 2017, the cost of servicing that debt has risen sharply forcing many Canadians to cut back on vacations and other leisure activities. Recently, the Central Bank hit the pause button on rate hikes allowing Canadians to on average save C$160 per year in income that would have otherwise gone to pay interest.

Central Bank Has Raised Rates BY 25 Basis Points (0.25%) 5 Times Since 2017

The Bank of Canada (BOC) started raising their target rates in July 2017, after oil prices retraced a portion of the value lost during 2015. Since then, the Bank has increased the target rate 5 times, each with 25 (0.25%) basis point increments, pushing the target rate from 0.25% to where it is today at 1.75%. Commercial bank also followed suit and increased the rate they charged on consumer loans, with the Prime rate increasing by a similar margin, and with similar timing. Over the same period the Prime rate has been increased 5 times from 2.7% in 2017 to 3.95% today. All commercial banks charge interest on loans that is some mark up above or below the Prime rate, whether or not it is stated officially, and whether or not the loan is fixed or variable. For example a 5 year variable rate loan from RBC today is roughly Prime rate - 0.4%, while a 5 year fixed rate loan is roughly Prime rate - 0.31% - similar margin with an incentive for the customer to choose variable rate loans.



Canadian Consumers Have a Debt of C$2.06Tn, With 46% immediately ImpactED By Rate Changes

According to statistics Canada, total loans to consumers and business individuals amounted to C$2.06 Trillion at the end of 2018. Our estimates indicates that approximately C$951Bn is variable - which accounts for personal loans, line of credits and variable rate insured and uninsured mortgages. When the Central Bank changes its target rate, the Prime rate also changes and the interest on all variable rate loans are changed within a month. Additionally, our estimates indicate that approximately C$11Bn of fixed rate loans are exposed to renegotiated rates in less than a year.

The average Canadian Household will SAVe At least C$160 per YEAr

With all facts considered, the average Canadian household will save at least C$160 per year because the central bank put a hold on rate increases. The total debt that will be impacted by rate change within a year amounts to C$962Bn at the end of 2018. Assuming the rate increase would have been 25 basis points or 0.25%, and that the interest rate on all loans would have been increased by the same magnitude, roughly C$2.4Bn per year in interest cost would have been added expenses to Canadian households. As at the 2016 consensus, the number of Canadian households was 15 million, which put the cost to the average household at roughly C$160 per year.


Bear in mind that this is the immediate cost to Canadians, and that second round and third round costs would put the final estimate significantly higher. Higher interest cost will also impact companies and other government institutions as well. These bodies will be forced to increase the prices of the goods and services they offer to their customers, which will further erode household purchasing power. Furthermore, there would also be a further slowdown in the economy, which would impact household incomes either through job cuts, cuts to overtime, or cuts to the number of hours worked. The economy is already on shaky footing globally and has been stated as one the primary reasons for the pause. According to the Central Bank:


Recent data suggest that the slowdown in the global economy has been more pronounced and widespread than the Bank had forecast in its January Monetary Policy Report (MPR). While the sources of moderation appear to be multiple, trade tensions and uncertainty are weighing heavily on confidence and economic activity. It is difficult to disentangle these confidence effects from other adverse factors, but it is clear that global economic prospects would be buoyed by the resolution of trade conflicts.
Many central banks have acknowledged the building headwinds to growth, and financial conditions have eased as a result. Meanwhile, progress in US-China trade talks and policy stimulus in China have improved market sentiment and contributed to firmer commodity prices.

For Canada, the Bank was projecting a temporary slowdown in late 2018 and early 2019, mainly because of last year's drop in oil prices. The Bank had forecast weak exports and investment in the energy sector and a decline in household spending in oil-producing provinces. However, the slowdown in the fourth quarter was sharper and more broadly based. Consumer spending and the housing market were soft, despite strong growth in employment and labour income. Both exports and business investment also fell short of expectations. After growing at a pace of 1.8 per cent in 2018, it now appears that the economy will be weaker in the first half of 2019 than the Bank projected in January.


Debt levels among households continue to remain elevated as historically low interest rates perpetuate the borrowing thirst. However, the debt binge cannot continue to forever, as with more debt comes more bubbles and irresponsible risk taking. There is no doubt that central bank have to normalize rates at some point, but for the time being the bank has to remain cautious and data dependent to avoid deflating the economy too quickly.



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