As a Canadian citizen, knowing the effects of an interest rate hike in Canada helps you think about your borrowing. Interest rate is the money the borrower pays to the bank or financial institution. It is a percentage of the amount loaned.
Interest rate hike increases the value of the Canadian Dollar. That’s due to an increase in foreign investments leading to higher demand for the Dollar. This article explores the causes of interest rate hikes, their effects, and the pros and cons of high dollar value.
Interest rate is the amount charged to the borrower of an asset. The asset is mostly cash but can also be consumer goods, vehicles, or property. Banks and other financial institutions charge interest rates on an annual percentage rate.
When there is an interest rate hike, borrowing money becomes expensive because the higher percentages increase the amount of the loan to be repaid. Unfortunately, that also affects homeowners with mortgages and other businesses that rely on loans.
Banks can charge lower interest rates to low-risk borrowers. These are consumers with a good credit record or those without a high debt that could make it challenging to pay another.
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Conversely, the bank will charge higher interest rates if you lack a good credit record because you are a high-risk borrower.
Different economic and political factors affect interest rates in a country. For example, the bank of Canada might have increased its interest rates by 0.25 percent due to inflation, supply and demand, fiscal deficit, and government borrowing.
Inflation is the price of goods and commodities in the economy. It happens when the purchasing power of money losses value. Inflation leads to a rise in interest rates since lenders want higher compensation due to the decrease in purchasing power of money.
For example, when you borrow $1000 from a Canadian bank today, you can buy many goods using the amount. However, the same $1000 won’t purchase you the same number of items in five years due to inflation.
Banks will increase the interest rate of borrowing $1000 to compensate for the decrease in the purchasing power of money. They do so to prevent losses.
Supply and demand of money will affect interest rates. Many people apply for loans when there is a high demand for money. The banks increase interest rates to discourage people from borrowing to reduce cash in the economy.
A decrease in demand for money will lead to a reduction in interest rates. As a result, banks and financial institutions lower interest rates to push citizens to borrow cash.
The supply of money increases when citizens open bank accounts. When you deposit money into the account, you are lending money to the bank, and they can use it for their business. It also means that the bank has enough money to lend to other people, reducing interest rates.
On the other hand, a low money supply means inadequate credit availability. It mostly happens when borrowers defer loan repayments, leaving the banks with little money. As a result, this increases interest rates.
A fiscal deficit is a difference between a government’s total revenue and expenditure. The deficit occurs when government expenditure is more than the revenue, resulting in borrowing.
When the fiscal deficit is high, the government borrows more. As a result, it leads to an increase in the interest rate of loans.
An interest rate hike due to inflation or low supply and high demand for money affects a country’s currency value. High-interest rates attract foreign investors into the country. These investors are likely to sell the properties denominated in other currencies and buy those denominated in Canadian Dollars.
This leads to an increase in demand for the Canadian Dollar, increasing its value. The result is a higher exchange rate for the Dollar, which you will notice when you exchange currency in different places. However, those who exchange their money at Knightsbridge FX might not experience too high exchange rates.
An increase in the Canadian Dollar’s value has pros and cons. Some pros are cheaper imports and lower costs for people who travel abroad.
Companies that import goods from abroad will enjoy cheaper imports when the Canadian Dollar increases its value. That happens due to a fall in the exchange rates. However, as the Canadian Dollar strengthens, the value of imports continues to fall.
Canadian companies that import raw materials from countries with a weaker currency will gain more profits. That is because they will have a lower cost of production, making larger profit margins than before.
An increase in the value of the Canadian Dollar increases the currency’s buying power. Therefore, you can buy more items in another country’s currency. Besides, you will get more money at the foreign currency exchange points, making your traveling cheaper.
If you live in a country whose currency value is lower than the Canadian Dollar and have investments in Canada, you get paid in dollars. These investors earn in CAD, which means more money when they exchange it.
Although foreign investors and global travelers benefit when the Canadian Dollar has a higher value, there are some downsides. The exporters earn less, and there is a decrease in tourism because it becomes expensive.
The tourism sector benefits most countries because it is an excellent source of money. However, when the Canadian Dollar increases in value, the prices of goods and services become expensive for foreigners. That’s because they get less CAD when they exchange their money, meaning they can buy fewer things and pay for fewer services.
Foreign investors in Canada who get paid in their country’s currency earn less due to the Canadian dollar increase. That could lead to reduced foreign investments because it is discouraging to investors.
Although Canadian companies enjoy low production costs, they won’t make a lot of profits on exports. It happens because they get paid in the other country’s currency which could be of lower value than the Canadian Dollar.
Canadians with companies abroad get lower income because of the increased value of the Canadian Dollar. That is because when they make sales in these other countries and get paid in the state’s currency, they get less CAD after the exchange.
Canada can control its interest rates by controlling the factors that lead to a hike. For example, the country can curb inflation by reducing the money supply in the economy. That causes a reduction in demand for goods, causing the prices to decrease.
Borrowers suffer when there is an interest hike in Canada. Borrowing mortgages and other investment loans become expensive, discouraging investors. That can lead to a negative impact on the economic growth of the country. Conversely, reduced interest rates will motivate people to borrow and invest, promoting economic development.
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