Did record household debt scuttle an interest rate cut?

Heading into the Bank of Canada’s (BoC’s) much-anticipated interest rate announcement yesterday, many observers were expecting another cut to bring the overnight lending rate down to 0.25 per cent. Instead, the BoC held rates at 0.5 per cent, which could be seen as a small victory for Canadian consumers currently struggling with record-high household debt levels—and rapidly rising food costs due to a low Canadian dollar.

In fact, just one day before the BoC’s interest rate announcement, the Parliamentary Budget Office (PBO) announced that the household debt to income ratio hit 171 per cent, its highest level since 1990. The PBO also warned that we’d see the end of historically low interest rates by 2020. There clearly were other factors holding lending rates at 0.5 per cent—the BoC’s news release cited inflation, the global economy and national employment levels, but it did mention that “household spending continues to expand.” The BoC also noted that “financial vulnerabilities continue to edge higher, as expected.”

And one of those financial vulnerabilities, if not the biggest one, is household debt. In October, BoC Governor Stephen Poloz made headlines when he said that rising debt levels were a “key risk” to our economy. The BoC also noted there were 1.5 million households carrying risky levels of debt, which could potentially destabilize the economy. So while an expansion in household spending might have been expected, the BoC also seems to recognize the risk of rising household debt—albeit not to the extent that they would raise rates to curb borrowing.

How an interest rate cut could hurt consumers

Amidst the general consensus that low oil prices and a struggling economy would lead to the third interest rate cut in about a year, there were some dissenting voices. The Globe and Mail’s finance columnist Rob Carrick gave eight reasons why a rate cut is a bad idea, starting first and foremost with the falling loonie. Carrick also noted that reduced rates were bad for seniors, savers, the housing market and millennials, who he accuses of assuming that higher rates are strictly a thing of the past. Carrick hits on a very real risk of rising rates: “The danger here is that people buy houses they can only afford at today’s low mortgage rates and then must contend with higher rates later on.”

Consumer confidence also weighed on the minds of some economists leading up to the BoC’s interest rate announcement. The news of a falling Canadian dollar has affected the morale of snowbirds and U.S.-bound travelers, while higher produce prices are coming at a time of severe job cuts in Alberta and other oil-producing provinces. Some say the loonie has already fallen far enough, with one bank’s chief economist suggesting that it’s currently 16 per cent undervalued. In that regard, any impact of a lower loonie could already be priced in.

Ultimately, our biggest concern is that an interest rate cut will encourage consumers to borrow more at a time when many are already facing record levels of household debt. Although the BoC’s rate decision doesn’t send the signal that Canadians should be spending more, it would still be a good idea to take advantage of low interest rates and start paying down debt.

Were you surprised by the BoC’s interest rate announcement? Join the conversation on Twitter using the hashtags #BDOdebthelp #LetsTalkDebt