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The Bank of Canada just hiked into ‘uncharted territory,’ thanks to hefty household debt

FILE PHOTO: A jogger runs past the Bank of Canada building in Ottawa, Ontario, Canada, July 11, 2018. REUTERS/Chris Wattie/File Photo
FILE PHOTO: A jogger runs past the Bank of Canada building in Ottawa, Ontario, Canada, July 11, 2018. REUTERS/Chris Wattie/File Photo

The Bank of Canada hiked its key interest rate by 25 basis points to 1.75 per cent, a sign that trade policy concerns are in the rearview mirror as the economy continues to signal strength.

The 25 basis point boost brings the trend-setting rate to its highest level since 2009. It’s the fifth time the bank has raised interest rates since July 2017.

John Shmuel, managing editor at the financial product comparison website, said less trade tension with the United States paves the way for more routine rate hikes down the road.

“The only thing NAFTA was really doing was threatening to slow down the rate hikes,” he told Yahoo Canada Finance before Wednesday’s rate decision. “Now that that’s gone, they are going to go right back to their regular schedule that we were seeing last year.”

Wednesday’s decision marks the first rate increase since Canada signed onto the new U.S.-Mexico-Canada Agreement. The central bank held its key overnight rate a 1.5 per cent in September, citing “elevated trade tension” as a key risk.

The interest rate increase ups the pressure on Canadians with variable-rate mortgages, and other non-fixed-rate debt.

Years of ultra-cheap borrowing costs since the financial crisis have seen household debt levels swell to record highs. Canadians owe $1.69 in credit market debt for every dollar of household disposable income, according to second quarter figures from Statistics Canada.

The closely-watched household debt-to-income ratio jumped from 168.3 per cent in the previous quarter, but remained below the 169.7 per cent observed in the second quarter of last year.

“We are kind of in unchartered territory because consumer debt is so high and we’re going back to normalizing rates,” Shmuel said. “If there was a time to hunker down, really budget and cut frivolous spending, now is the time to do it.”

In its September release, the Bank of Canada noted that “credit growth has moderated and the household debt-to-income ratio is beginning to edge down.”

Shmuel said Wednesday’s rate decision could add as much as $200 to an average monthly payment for someone with a variable-rate mortgage in a major city like Toronto, depending on a number of factors.

He notes that while there has been some encouraging data suggesting Canadians are paring down their debt, there is also evidence that many cannot afford heftier monthly costs.

Most economists expected Bank of Canada Governor Stephen Poloz to strike a more hawkish tone in the latest quarterly monetary policy report as he forges ahead with his “gradual approach” to raising rates.

“The bank has a solid case to make for moving in October,” CIBC chief economist Avery Shenfeld wrote in a research note last week. “A quarter-point hike on Wednesday will be no surprise, accompanied by language on economic conditions to explain its necessity.”

Inflation and retail sales came in weaker than expected last Friday. Statistics Canada said the annual inflation rate dipped to 2.2 per cent last month. September marked the eighth consecutive month that the overall inflation rate has exceeded the central bank’s two per cent target.

BMO economist Douglas Porter predicted the final release of data before Wednesday’s decision would not break the central bank’s determination to raise interest rates.

“The one-two punch of softer inflation and retail activity does dull the recent shine of the economy, but we still expect the BoC to proceed,” he wrote in a note to clients before the announcement.

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