ridingwaveinterestratesOn January 21, 2015 the Bank of Canada surprised markets by cutting the interest rate by one-quarter of one percentage point to 3/4 per cent. The Bank Rate is correspondingly 1 per cent and the deposit rate is 1/2 per cent. This decision is in response to the recent sharp drop in oil prices, which will be negative for growth and underlying inflation in Canada.

The first of Canada’s big banks to trim borrowing costs was Royal Bank of Canada, decreasing its prime lending rate to 2.85 per cent from 3 per cent. The move was quickly matched by the Bank of Montreal, TD Canada Trust, CIBC and Scotiabank. The rate changes take effect Wednesday, January 28, 2015.

Canada’s biggest banks have come under fire for not immediately cutting their lending rates after the central bank’s rate cut. It took a full week for the banks to react and lower their prime rates.

By not passing on the full rate cut to borrowers, the banks can protect their net interest margin, which boosts profits.

Typically, once one bank cuts its prime rate, the others follow in order to remain competitive with borrowers.

RBC called its move “a balanced approach which reflects our actual cost of funds and helps clients save money on products such as variable-rate mortgages, lines of credit and floating-rate loans,” an RBC spokesperson said in an email to The Star.

The move will undoubtedly help borrowers and home buyers, but will it enable consumers to purchase above their means of repayment? After all, we do carry a high debt-to-income ratio. According to Statistics Canada, Canada’s household debt-to-income ratio hit a record high in the third quarter of 2014, climbing to 162.6 percent from 161.5 percent in the second quarter.

What can consumers expect from the lower rate?

TD Canada Trust forecasts the downward trend will lead the Bank of Canada to cut the overnight rate by another 25 basis points to .5 per cent, before standing pat until the second half of 2016. The bank also projected in a recent report, “Lower corporate profits will likely lead to a contraction in business investment and weaker employment growth relative to our December forecast.” The unemployment rate will rise to 6.9 per cent by the end of the year, and stand at 6.7 per cent at the end of next year.

There is a possibility the Canadian dollar could drop even further – as low as 75 cents US in early 2016.

The next scheduled date for announcing the overnight rate target is 4 March 2015. Seeing how the markets are so unpredictable, we will have to wait and see how the Bank of Canada will act. Until then we hope consumers keep their heads concerning their budgets and spending. This ride is not over yet.

For more about the affects of interest rates on Canadian consumers, Interest Rate Increase will Hurt Canadians with non-mortgage debt.

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