COLUMN: Higher interest rates will slow B.C. economy after ‘unusually robust’ show

COLUMN: Higher interest rates will slow B.C. economy after ‘unusually robust’ show

Jock Finlayson is executive vice president and chief policy officer of the Business Council of BC

By Jock Finlayson

When it hiked its short-term policy interest rate in late October, the Bank of Canada signaled that an extended period of “money for nothing” – the lowest interest rates in Canadian history – had finally and definitively come to an end.

Last month, the central bank lifted its benchmark overnight rate to 1.75 per cent, which is up from a record low of 0.5 per cent in the summer of 2017. Over the past 15 months, the Bank of Canada has nudged its policy rate steadily higher, albeit in baby steps. Why does this matter?

READ MORE: Bank of Canada hikes interest rate to 1.75%

The reason is that many other interest rates in our economy, including mortgages, lines of credit, and the rates paid on savings accounts and Guaranteed Investment Certificates, are influenced by the Bank of Canada’s rate-setting decisions.

So, as the central bank has been raising its benchmark rate, borrowing costs for consumers, home-buyers, businesses and governments have been rising in tandem. To a lesser extent, savers have also seen slightly higher returns on the money they hold with banks, credit unions and other financial institutions.

Based on statements from Bank of Canada governor Stephen Poloz and his colleagues, it appears that the bank expects to keep interest rates on an upward trajectory in 2019-20. Of course, this assumes the Canadian economy continues to post modest growth going forward.

READ MORE: Feds to release fall economic update Nov. 21

Some prominent forecasters see the bank’s benchmark policy rate approaching three per cent by mid-2020. If so, the market-determined interest rates facing households and businesses are likely to keep climbing for a few more quarters at least.

The shift from years of rock-bottom interest rates to somewhat more “normal” rates will have widespread effects across the economy. With the cost of credit escalating, consumer spending in Canada is set to slow. So too will key measures of real-estate-related activity, as rising mortgage rates take a bite of housing demand and quash speculation.

British Columbia is more vulnerable than other provinces to the tighter financial conditions being engineered by the central bank.

READ MORE: Housing slowdown forecast to cool B.C. economy

With the most expensive homes in the country, B.C. also “leads” in the amount of debt accumulated by consumers and households – both in absolute terms, and relative to household incomes.

Mortgages make up more than two-thirds of household debt. Thus, costlier real estate means bigger mortgages and a higher debt/income ratio for the average B.C. household.

Estimates suggest that 70 per cent of Canadian households with five-year fixed mortgages as of 2017 will have renewed at a higher rate by the end of 2020. Around one-fifth of these households are in B.C. People with variable rate mortgages will also be paying more in interest costs going forward.

What do higher interest rates portend for the province’s economy as a whole?

First, like Canada, B.C. will see a downshifting in the growth of consumer spending – a trend that is already evident in the data on retail sales in 2018.

Second, housing markets, which have softened in 2018, should stay subdued for some time, as mortgage rates edge up and more restrictive federal government rules on mortgage financing continue to weigh on lending. The NDP government’s measures to curb housing demand and increase the tax burden on expensive properties are also playing a role in taking the froth out of the real estate sector.

Overall growth in the B.C. economy is poised to slow after the unusually robust performance seen in 2016 and 2017.

For 2018, the Business Council of B.C. projects a 2.3 per cent increase in inflation-adjusted gross domestic product, down from average growth of 3.8 per cent over the previous two years.

In 2019, we anticipate a small pick-up in economic activity, fueled in large part by higher investment spending – specifically, the start-up of LNG Canada’s massive gas liquefaction project in Kitimat, by the middle of next year.

READ MORE: Kitimat gets first look at LNG Canada timeline

Looking ahead, it is clear that B.C. will have to rely more on non-residential investment and exports to underpin an expanding economy, as the province moves away from the real estate-centric growth model that prevailed during the era of record low interest rates.

Jock Finlayson is executive vice president and chief policy officer of the Business Council of British Columbia

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