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Rising Interest Rates in Perspective

General Vivian Pritchard 10 Jun

When the Bank of Canada raised its Bank Rate by 25 basis points to .75 per cent last Tuesday, there were already a few grumblings from Canadians in the housing sector and elsewhere who thought interest rates should remain at an effective rate of almost zero for time immemorial so they could continue to borrow cheaply. That would be unwise and short-sighted for reasons to be explained.

Of immediate concern is that there are perhaps too many Canadians, at least those under the age of 40, with no historical recollection of how unique the current low-interest rate environment has been and still is.

A bank rate of half a percentage point (and an overnight rate of .75 per cent) is unheard of in Canadian history, at least as far back as Bank of Canada records go which is to 1935. In the depths of the Great Depression, the central bank rate never dipped below 2.5 per cent. In the late 1940s and until 1950, the rate did decline to 1.5 per cent, but never lower.

In the later 1950s and 1960s, generally seen as the golden age of Canadian prosperity, the bank rate starting moving up from two per cent, and then to a higher range, including six per cent in 1962, and as high as eight per cent by the year of Woodstock in 1969.

While central bank rates dropped a bit in the early 1970s, the lowest they ever sunk to was 4.75 per cent between late 1971 and early 1973. After that, Bank of Canada rates spiralled upwards to 14 per cent by the end of 1979 and hit a high of 21.03 per cent in August 1981. While rates dipped marginally in the 1980s, relatively speaking, they never fell below seven per cent (in 1987) and were as high as 14.05 per cent as recently as 1990.

Over the last 20 years, consumers and home buyers have become accustomed to ever-decreasing interest rates, the extreme low occurring this past year.

But that anomaly only exists because the world was almost plunged into another Great Depression in the fall of 2008 with the collapse of Lehman Brothers, scores of bank bankruptcies, a U.S. housing crash, a stock market crash, and a credit seize-up even between financial institutions. The present Bank of Canada rate is thus an emergency rate, still, and nothing more. It cannot be expected to last unless economic conditions again worsen.

It’s worth remembering that the reason interest rates became so high in the 1970s and 1980s is because inflation was allowed to spiral out of control. That necessitated high interest rates to kill inflation, and it’s why a five-year mortgage went for 21.46 per cent in September 1981.

The Bank of Canada was correct to raise interest rates this past week; it was right to get ahead of the recovery and prevent inflation from again rearing its destructive head. It may be that continued economic weakness around the world forestalls another rise in the central bank rate, but such conditions are not then a cause for cheer.

Regardless of what occurs in the short-term, the long-term prognosis is for higher inflation around the world because of soaring sovereign debt levels around the world and thus higher lending rates. That means Canadians should act prudently, and be careful about excessive debt taken on in a low interest-rate environment. It cannot and will not last forever.