The spread of COVID-19 has impacted the Canadian economy in many ways. It’s caused a decline in tourism, a disruption in the import and export industry, an increase in consumer debt, a decrease in business activity and an overwhelming health crisis. As a result, the economy has been adversely affected. In an effort to help Canadians and businesses affected by COVID-19, the Government of Canada introduced a number of financial support programs. Similarly, the Bank of Canada has slashed its interest rate to 0.25% to help the economy’s recovery. This is particularly significant for Canadians who are looking to borrow, save, or invest.
Bank of Canada Interest Rate
As mentioned the Bank of Canada has slashed the benchmark interest rate to a historical low due to COVID-19. According to a recent announcement by the Bank of Canada, the 0.25% interest rate is expected to hold until 2023. The Bank of Canada explained that they plan on holding “the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved.”
Isn’t The Economy Doing Better?
Despite the recent development of the COVID-19 vaccine, the increasing oil prices, and the general rebound of the economy in the third quarter, the Bank of Canada knows that the amount of uncertainty many Canadians and businesses are facing is unusual right now. Moreover, with the recent uptick in COVID-19 cases and the increasing restrictions, it is bound to stagnant growth. The decrease in rate is expected to support the economy’s recovery by boosting consumer spending and business activity as the slashed interest rate provides Canadians and Canadian businesses with access to cheaper capital.
What Does This Mean For Canadians?
When the Bank of Canada lowers its interest rate, banks too reduce their interest in terms of lending, saving, and borrowing. Here are a few ways the lower Bank of Canada interest rate can affect Canadians:
When the Bank of Canada reduces its interest rate, big banks follow suit by reducing their prime rate. Since March of 2020, the prime rate in Canada has dropped from 3.45% to 2.45%. This in turn affects the cost of borrowing for mortgages.
For example, when you apply for a variable rate mortgage, the rate you are offered is based on your bank’s prime rate which is affected by the Bank of Canada interest rate. So if you have a variable rate of prime minus 0.20%, you’ll be paying 2.25% – 0.20% (= 2.05%) as opposed to 3.45% – 0.20% (= 3.25%). The lower the prime rate the less you’ll pay in interest. This, in turn, makes homeownership more affordable and accessible. Similarly, if you’re currently looking for a mortgage, you can opt to secure a lower rate for the next 5 years. If you already hold a fixed-rate mortgage, you may want to consider refinancing.
With interest rates slashed to near 0%, Canadians can take advantage by refinancing their debts. Many Canadians have been thinking about refinancing their mortgages. Despite the penalty of cancelling a contract early, the interest savings you receive from refinancing may be well worth it. Moreover, if you’ve been looking to borrow money, now is an ideal time as the low-interest rate also affects other credit products like variable loans and lines of credit.
It’s important to note that, while the Bank of Canada interest affects mortgages, variable loans and lines of credit, it usually does not affect fixed-rate debts like credit cards.
Borrowing to Invest
Borrowing to invest is always a risk due to the volatility of the stock market. However, according to the Globe and Mail, borrowing at the current rates means your probability of earning a profit from borrowing to invest is higher as the “break-even rate of return declines as well”. Overall, it’s important to do your due diligence and invest according to your risk tolerance. Diversifying your investments and starting with a long-term investment can help soften the effects of any short-term volatility.
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Unfortunately, while the slashed interest rate decreases the cost of borrowing it also decreases the earn rate on saving accounts. You may have noticed that many financial institutions have cut their high-interest savings account rate by as much as 50% since the start of the pandemic. So, while you may have an easier time finding affordable credit, you may see a slump in your savings.
With rates at historically low levels, Canadians can use these interest rate cuts to their benefit. If you’re looking to borrow money, now is one of the best times. You can expect the rates to remain low until 2023 when inflation rates are expected to reach the targeted 2%. However, it’s important to stay up-to-date with the news as the rate changes along with the economy’s recovery. As such, if the inflation rate reaches 2% before 2023, the Bank of Canada is likely to raise the interest rate.
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