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Why are interest rates so low?
- Low population growth: A high population growth results in more people entering the economy each year which inevitably means more people that request loans and go into debt. Canada’s population growth has hovered steadily around 1% for the last two decades.
- Relatively high borrower to saver ratio: Rising interest rates are driven strongly by demand for them. In developing economies, there tends to be much more borrowing going on than saving as people try to get a foothold in life. In developed countries, like Canada, people simply aren’t that desperate. Let’s also not forget that it’s technically savers that finance borrowers. Having a more balanced borrower to saver ratio therefore leads to lower interest rates.
- Current policy: Governor of the Bank of Canada Stephen Poloz and his peers have been actively trying to keep interest low. Measures that they see as making sure only the most qualified lenders give out loans and give Canadian households some breathing room financially.
Why would rising interest rates be a big concern?
One of the chief reasons for concern is the effect it would have on potential borrowers who already have to meet strict requirements to get a loan in the first place. When you are assessed for a loan in Canada, you are benchmarked for risk against an interest rate that is 2% higher than the actual interest rate on your loan or mortgage.
That means borrowers need to prove themselves according to a 5% interest rate if they get a loan with an average interest rate of around 3%. If interest rates were ever to rise to the 5% mark, this means borrowers would be assessed according to a steep 7% interest rate.
This would be bad news for most new citizens hopeful for a new loan or who want to refinance. Mix it with a housing-bubble of immense proportions and many would simply be unable to afford a home.
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Reasons the interest rate looks safe (for now)
Recent history and current policy
It seems that the authorities at the moment feel safe and justified in their policies of keeping the interest rates low, even as Canada has been struggling with sluggish economic growth for a few years now. This year has seen the first interest hike in seven years (from 0.5%-0.75%). That alone should tell you a lot.
Poloz has also recently expressed his view that Canada has emerged from this slump and their failure to hike up interest again recently as some expected, signal that they are likely to continue the trend.
Unlikely shift in demographics
We mentioned before that some of the factors that drive Canada’s low interest rates are slow population growth and a good borrower to saver ratio. This is unlikely to change based on current and past data. Also, Canada is not as affected by the recent uptick in immigration as many other developed countries further reigning in any drastic change.
Little to no inflation
Inflation drives interest rates up. It’s as simple as that. This is not only a phenomenon in Canada at the moment but a global trend as a result of globalization that means there is always a steady supply of workers, competition from huge businesses such as Amazon that keeps prices from rising, and the replacement of workers by technology as well as the lowering cost of manufacturing.
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