Interest rates have been at a low point for quite some time, and the Brexit vote contributed to expectations that they’ll stay low for the foreseeable future. But there’s also a possibility that they’ll drop even farther. How low will they go?
The central banks in some countries – Denmark, Japan, Sweden, and Switzerland, to name a few – have dropped their key interest rates below zero, in part, to combat deflation. If interest rates drop below zero, then banks have to pay the central bank to hold its deposits. This eats into the bank’s profits, and for consumers, this can mean attempts to recoup some of those losses through higher fees. The idea, however, is the same as is it is with any drop in interest rates: In an economic crisis of any sort, banks are less willing to lend money and borrowers are less willing to borrow money, so by making it more costly to hold on to money, negative interest rates theoretically keep money circulating in the economy, either through lending or investing.
“My guess is we won’t see negative interest rates in Canada, and even if we were to see negative interest rates on government bonds, that’s not exactly the same as a mortgage,” said Nick Rowe, associate professor of economics at Carleton University. “A mortgage is always going to be a bit riskier than a government bond so there’s always going to be a bit of a risk premium on them so you’ll be paying a higher interest rate. The government’s safer than we are.”
An economic study by Dejardins also concluded that Canada is “standing on high ground compared with those of many European countries, and disinflationary pressures here are not as strong.” Rather than boosting the economy here, veering into negative interest rate territory “could create more instability in the medium and long terms. Furthermore, households might simply fail to react to the more favourable borrowing conditions if they felt they already had enough debt on their shoulders,” whereas “the same measure, applied in the euro zone, promises better results. Households there have lower debt loads, since credit growth plunged in 2008.”
Canada has never operated in negative interest rate territory, but that doesn’t mean it couldn’t happen. Low interest rates have made borrowing money very cheap, but has also led to consumers are taking on loads of debt, and, when it comes to mortgages, homeowners could be at risk of being unable to afford their payments if – and when – interest rates rise. Lowering rates could contribute to more mortgages, more debt, and an increasing demand for properties that are already in short supply.
“Even if [rates] stay like this on average, you don’t know what’s gonna happen,” Rowe said. “Always make sure you’ve got a big margin of safety if you’re getting a mortgage in case things move against you.”
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