Interest rates are about to rise south of the border and Canadians will feel it - Action News
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Interest rates are about to rise south of the border and Canadians will feel it

There are few certainties in life, but if the experts who monitor the U.S. central bank are to be believed, one of them is that the Federal Reserve is about to raise interest rates and Canadians should be ready for spillover effects.

Canada has had a higher benchmark interest rate than the U.S. for almost a decade. That could change this week

Economists who cover the Federal Reserve think it's a virtual certainty that Janet Yellen will raise America's central bank rate on Wednesday. (Andrew Harrer/Bloomberg)

There are few certainties in life, but if the economists and experts who monitor the U.S. central bank are to be believed, one of them is that the Federal Reserve is going to raise interest rates this Wednesday.

If and when that happens, it will trigger something that hasn't happened since 2007 Canada will have a lower central bank rate than the U.S.

Canada is inextricably linked to the U.S.,so anything that happensthereis bound to have spillover effects here,and the two economies are telling vastly different stories at the moment.

In the U.S., the economy was expanding at a 3.2 per cent annual pacein the third quarter, its fastest rate in two years. The job market is also booming, with the jobless rate dropping to a nine-year low of 4.6 per cent.

In Canada, meanwhile, the picture isn't looking quite as rosy. While doing slightly better than 2015's low bar,the economy is forecast to only expand by 1.1 per cent this year,and the vast majority of new jobs being created are part-time.

'Economic slack remains' in Canada

With numbers like that, it's not hard to see why the two central banks are leaning in opposite directions.

In its latest policy statement, the Bank of Canada did the expected and kept its rate right where it has been for more than a year, at 0.5 per cent. While keeping its toes planted firmly on the sidelines, the bank noted "a significant amount of economic slack remains in Canada, in contrast to the United States."

That's the central bank's way of telling financial markets that the winds of change are blowing.

"This is a strong signal that the path of monetary policy for the two countries will likely diverge in the months ahead," said economist Craig Alexander with the Conference Board of Canada.

Impact on borrowers

When thecentral bank's rate moves, it has an effect on variable-rate mortgages. But more Canadians have fixed-rate mortgages, which are linked to what's happening in the bond market, which responds to market forces.

That means, somewhat counterintuitively, that Canadian borrowers renewing the terms of their loans may soon be asked to pay more, even as thecentral bank in this countryis contemplating making borrowing cheaper.

That's because of the Donald Trump effect on bond markets, where borrowing is becoming more expensive.

The yield, or interest rate, on a 10-year U.S. government bond has soared from 1.75 per cent the day before the election to 2.4 per cent. That may not sound like much, but in the stodgy world of bonds, a jump like that in barely a month is huge.

The Bank of Canada, which is led by Stephen Poloz, kept its key rate steady last week. (Chris Wattie/Reuters)

And Canada isn't immune to that shift, since the bond market is international. A 10-year government of Canada bond is currently yielding almost 1.7 per cent. As recently as the end of September, it was below one per cent.

That boost in bond yields is a big factor in pushing up fixed mortgage rates in Canada, where big players likeTD Bank and Royal Bank haveeach hiked some of their mortgage rates in the past few weeks. Expect more banks and mortgage companies to follow with rate hikes of their own.

"A message for markets," TD Bank economist Brian DePratto said, "was not to expect the Bank of Canada to follow the Federal Reserve's lead."

Mortgage rates won't be the only thing to feel the effects of a U.S. rate change, expected to be announced this week. If the Fed hikes rates while the Bank of Canada keeps its rate low, that's a recipe for a weaker Canadian dollar.

"At a minimum, the loonie is likely to remain close to its current level around 75 cents US," TD economist Beata Caranci said.

The Fed has been signalling loud and clear that it's ready to start inching rates higher, pointing in recent months to a strengthening U.S. labour market and inflation that is closer to its target rate of two per cent.The only question that remains is how quickly it will move rates upward in the coming yearand how high it will allow inflation to rise.

It's treading carefully because every move it makes has a ripple effect on markets both in the U.S. and internationally. A rising U.S. dollar could hurt other currencies and move bond markets, affecting borrowing around the world.

"The last thing the Federal Reserve likely wants to do with its policy decision on Wednesday is to fan the flames of the bond and currency markets,"Scotiabank'sDerek Holt said. But if that happens, the unintended consequences on Canada's economy could be deep.