Bank Of Canada governor Mark Carney must feel like a parent nagging a teenager.
Carney has been reminding us once again that interest rates can’t stay low forever. We all nod in acknowledgement. Then, we go about our business, signing mortgages, keeping credit card balances high, snapping up real estate and complaining about pensions. Even the banks are getting in on the fun by undercutting each other on mortgage rates to fatten their market share before interest rates finally do start to rise.
There have been plenty of warnings that as long as interest rates remain razor-thin, it will be difficult to fund pensions and life insurance policies. Housing prices will be in danger of becoming unsustainable. And stock market volatility will be a constant threat.
Just as high interest rates had posed a threat to the economy for most of the 1980s and 1990s, ultra-low rates could soon threaten our ability to save and fund future economic growth. Insurers and pension funds historically have depended on bonds for stability in meeting their future obligations. But with depressed interest rates and a stock market that hasn’t gained much over the past decade, shortfalls will continue to be common.
To increase yields, pension funds will be buying longer-term bonds. But this could make their portfolios more vulnerable in the future because longer-term bonds fall faster when interest rates rise. Extra volatility in the pension sector is about the last thing the capital markets need.
To sustain profits, banks will be looking to higher service fees to make up for depressed interest yields. Savers, particularly those on a fixed income, won’t see much incentive for saving at all.
Canadians may continue to complain about their pension plans being underfunded. But very few have connected the dots to what is causing the instability. This could be because the 18% mortgage rates of the 1980s are still etched in the memories of many. We have grown up with a two-dimensional view of lending rates – high interest rates, bad; low interest rates, good.
As a result, no politician in Canada or the U.S. will dare say unequivocally that interest rates will have to rise soon. That would be political suicide.
Yet, there will come a point when ultra-low interest rates will be doing Canadians more harm than good. But how long will it take before we realize that?
The U.S. Federal Reserve Board had announced in February that interest rates are very likely to stay low through to the end of 2014. So, the Bank of Canada and the Department of Finance will have another couple of years to continue to nag and nudge us to be prepared for the big change.
The change in Canadian mortgage-underwriting rules made in late March is part of that cajolling process. Expect the feds to be increasingly strict about borrowing rules.
At some point, Ottawa is going to have to step up its efforts to prepare Canadians for the inevitability of higher interest rates, just as it must prepare people for tighter fiscal policy to get rid of the deficit.
That could be a problem for the government of Prime Minister Stephen Harper. Since the autumn, it has struggled to do the necessary advance work for this spring’s austerity budget, let alone deal with the fallout from the coming period of rising interest rates.
A polarizing effect will soon be very visible among Canadians, just as there was in the high interest rate years. Rate junkies stocking up on certificates of deposit and T-bills love high borrowing costs. But if you are in the real estate business, you probably love depressed interest rates.
In the meantime, the governor of the Bank of Canada will carry the burden alone while Canadians continue to wonder what happened to their retirement plans or why the economy can’t grow enough to stop the rising income disparity and unemployment.
The electorate could be in a very unpleasant mood by the time the 2015 federal election campaign begins – just as Canadians were in the late 1970s after the stagflation years.
© 2012 Investment Executive. All rights reserved.
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