Latest decrease in interest rates and its effect!

Five things to watch after the Bank of Canada's latest rate cut


The decision that practically gripped the nation came down this morning, as Bank of Canada Governor Stephen Poloz decided to cut interest rates once more. The first of his cuts came more abruptly when in January of this year, the BoC shaved 25 basis points off what was thought to be a stable 1 per cent; it was the first rate cut since April, 2009, and was a direct response to the steep drop in oil prices.


Wednesday's rate cut to 0.5 per cent was less of a surprise as the economy has not rebounded as the central bank expected. Now, not only did the BoC cut its rates, but it dramatically lowered its growth projections for the rest of the year.


Below are five things to watch out for after the interest rate cut.


How will the banks react?


The question now is whether the banks will follow suit and cut their own prime rates in response to the rate cut - and by how much. Toronto-Dominion Bank was the first of the big banks to react. Shortly after BoC announcement, TD cut its prime lending rate by 10 basis points, bringing its rate down to 2.75 per cent as of July 16. Later Wednesday, Royal Bank of Canada dropped its prime rate by 15 basis points to 2.70 per cent, also effective July 16. Bank of Montreal followed with an identical move to RBC's.


Depending on how the others react to the cut, the country's banks may have more customers looking for cheaper mortgages, they'll be able to borrow funds at a cheaper rate, and they may not have to pay out as much to depositors. However, with cheaper borrowing rates come a hit to their lending margins as they are largely expected to follow the rate cut by cutting their prime rates. Time will tell how each of the banks react.


How will the housing market be affected?


Lower interest rates may add fuel to an already scorching housing market as potential homebuyers shop for more favourable rates. A Teranet-National Bank home price index released Tuesday found home prices rose 5.1 per cent in June from a year earlier. This frothy seller's market may put more upward pressure on these already historic prices.


However, with cheaper debt comes more responsibility. Homeowners are expected to still watch their household debt.


Borrow more, invest more


With cheaper cash available comes more investing opportunities for Canadians. It is expected that stock markets may get a boost from an increase in the number of stock holders willing to take the risk, especially considering now that bond yields will decline further with a dip in interest rates.


Drag on the loonie


The loonie reacted to the news by tumbling more than a cent to 77.5 cents (U.S.) from its opening this morning of 78.57 cents. Rahim Madhavji, president of Knightsbridge Foreign Exchange, said this means funds will be fleeing the country in search of better bond yields.


The money supply also dictates which way the currency will swing. When access to money is cheaper, more people will borrow and spend. When more people spend money on goods, suppliers of goods will increase production to meet that demand. When supply can't keep up with demand, the costs of goods rise, weakening the purchasing power of the currency to buy those same goods. The loonie, as some analysts have pointed out, may have been sacrificed for better times ahead.


Exports and imports


The weaker loonie means two things: imports are more expensive and exports are cheaper to foreign buyers. For importers, costs may go up. Retailers, for example, may see their import costs rise and as a result, may raise prices of goods to cover their margin loss. As for exports, Mr. Poloz said that weaker-than-expected growth in the U.S. and China in 2015 are to blame for some of the country's export woes. Now, the BoC is serious about nudging exporters toward better months. Still, it was expected - on the strength of non-oil exports, such as car parts, lumber, machinery and equipment - that Canada would rebound from the last time the BoC cut rates. Evidently, it did not.


Looking ahead, a lot is riding on how the U.S., Canada's largest trading partner, manages its own growth. Federal Reserve chair Janet Yellen said Wednesday that the U.S. central bank is on track to raise interest rates this year. So, if exports are a primary issue for the BoC, then we will definitely want to look south of the border intently.


AHMAD HATHOUT   The Globe and Mail     Published