Four things investors need to know about rising interest rates
Central banks in many countries have switched course from a policy of lower interest rates and quantitative easing to one dedicated to combating inflation. This means increasing interest rates and also unwinding bond purchase programs. Most recently, on July 13 the Bank of Canada (BoC) surprised economists by increasing the overnight interest rate by 100 basis points to 2.50%, a third consecutive hike following the 50 basis points hike in June.
This latest rate was a surprise, as many economists anticipated another 50 basis point in crease in line with previous rate increases. This was the first 1% rate hike since 1998. The Bank of Canada also revised its outlook with lower economic growth for this year and the next. Due to increasing concerns around inflation, additional rate increases are likely in the months ahead. It’s important that investors consider the impact of rising rates in the near and long term.
Here are four things that DIY investors should focus on:
The strength of the economy
Despite revisions to GDP growth outlook from 3.5% to 4.25%, the BoC’s rate move can be viewed as a vote of confidence in the economy, which, while still facing some challenges, is exhibiting enough underlying strength for domestic policymakers to shift their attention to moderating inflation and price stability. The labour market continues to show strength with the Canadian jobs report in July showed the unemployment rate at 4.9%. According to the BoC’s June 1 statement, “Canadian economic activity is strong and the economy is clearly operating in excess demand,” with the central bank citing several key indicators:
- National accounts data for Q1 2022 showed GDP growth of 3.1% (quarter on quarter), in line with the BoC’s April Monetary Policy Report projection.
- Job vacancies have been elevated, with companies reporting widespread labour shortages and wage growth increasing and broadening across sectors.
- Housing starts remain robust, despite moderating house prices.
- Consumer spending in Canada remains robust and exports are expected to strengthen, fueling expectations for solid growth in Q2 2022.
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More interest rate hikes are coming
The BoC expressed its ongoing inflation concerns in July, stating that “Inflation in Canada is higher and more persistent than the Bank expected”. The central bank’s statement suggests they it is likely that the BoC will continue to hike rates into restrictive territory later this year and then observe economic indicators to see what future actions might be needed. While some expect the pace of rate increases to slow after July, the degree to which this happens will depend on the BoC’s reading of economic data.
Housing market is a key indicator
The Canadian economy itself is highly sensitive to interest rates, compared to the U.S. economy for example, due in part to the proportionately large role of the housing sector in Canada. A slowing housing sector could signal some of the economic cooling that the BoC is looking for, which would help moderate inflation and give the central bank more options on policy moves going forward.
Expectations for the U.S.
The U.S. Federal Reserve is also expected to raise rates by 75 basis points in July as well. There are already signs of the desired economic cooling in the U.S., with new home sales falling 16.6% in April, downward price pressure in the housing sales market overall, and slowing expansion in manufacturing and services as gauged by the U.S. purchasing managers’ index.
What this means for investors
Four major headwinds have fueled market volatility in 2022: inflation, central bank policies, the war in Ukraine, and the pandemic. These issues have not dissipated for the most part, and markets will likely continue to be volatile in the near term. Equity market valuations have come down to more attractive levels as a result, which may provide good entry points for longer-term investors for when market sentiment turns more positive.
Inflation and interest rates will likely continue to make headlines in the months ahead, but investors shouldn’t let short term market volatility derail their investing goals. Investing regularly through different markets has continued to reward investors with a long-term time horizon. We will continue to provide information and insights that help you invest with confidence.
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The information contained in this article was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This material is for informational and educational purposes and it is not intended to provide specific advice including, without limitation, investment, financial, tax or similar matters.