Bank of Canada Cuts Interest Rates

Bank of Canada

In the second surprise of the morning, Bank of Canada (BoC) announced that the interest rates will be cut from 1% to 0.75%. That 25 basis points may not seem like much, but it goes to show that all is not well with the Canadian economy. The slump in the oil and energy sector has seen numerous job cuts announced with more to come. One report has suggested that the Canadian tar sands might see upto $60B in capex cuts over the coming weeks and months. Not just the oil sector, retail stores have been announcing bankruptcy and/or simply just pulling out of the Canadian market.

A move to cut rates from the BoC was expected, but not until later this year. There have been plenty of indications – both from the bond market and the forex market to suggest that the Canadian interest rates would be cut. Some banks were expecting that announcement to come later in the year. Following is the statement from BoC.

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Impact of Interest Rates

Changes in interest rates can have a huge impact on your portfolio. With interest rates at historical lows (in US and Canada), it is only a matter of time before they start rising. This post discusses how the rise in interest rates affects each sector.

Rising Interest Rates

When interest rates rise, credit becomes more expensive and the equity market will tend to falter a bit as a first reaction, but as the economy improves, the equities will recover.

  • Bonds: Bonds are the most sensitive asset class to changes in interest rates. Bond prices fall effectively increasing the bond yields.
  • REIT: REITs fall (initially). REITs become an alternative for income investors during low interest periods. The more interest rates rise, the less REITs make because they have to pay higher borrowing costs. REITs may later perform well after the initial fall if inflation picks up – see ‘Inflation’ below for details. Click here to read more about impact of interest rates on REITs.
  • Financial sector: The financial sector will produce winners and losers. The banks that are well capitalized perform better than others. Banks with a heavy focus heavily on mortgages could benefit from the increased earnings from mortgage payments.
  • Energy infrastructure: This sector tends to fall. The increase of debt on the companies puts a downward pressure. Exceptions include companies with high growth potential or long term contracts.
  • Utilities: Utilities fall. When interest rates are low, bond investors turn to utilities as next-best alternative for yield. With rising interest rates, investor return to the safe haven of bonds driving stock prices in the utilities sector lower.
  • Inflation: One of the motivations for the central bank to rise interest rates is the threat of inflation. If inflation is high, sectors such as REITs, commodities (gold, oil), inflation-indexed bonds etc will do well after the initial jitter in the markets.
What are your thoughts on the impact of interest rates?
Disclaimer: The information provided here is for educational purposes only. All opinions here are my personal opinions and should not be taken as financial advice. I am not qualified to be a financial advisor. Always consult with your financial advisor before investing in any of the companies mentioned on this blog.