How Bank of Canada’s Interest Rate Hike Effects Your Credit Card
Raised Interest Rates
On 12 July 2017, the Bank of Canada raised its key interest rate from 0.5% to 0.75%. The key interest rate defines the rate at which banks lend money to one another, and forms the basis for determining interest rates for other borrowings. This is the first increase since September 2010, with some economists predicting an additional hike of 0.25% next October. The bank increased the rate due to the higher than forecast rate of GDP growth. This coupled with concerns about high level of consumer debt and an overheated housing market. This is especially true in major regions such as the GTA and Vancouver. The Bank of Canada expects the economy to grow by 2.8% this year, higher than the 2.6% pace estimated in its April forecast. According to Douglas Porter, Bank of Montreal chief economist, the central bank could increase its rate up to 1.5% by mid-2018.
The major commercial banks matched the central bank’s rate increase by raising their prime rates by 0.25% to 2.95%. Prime rate is the rate that the banks charge their best customers. Those who have the highest credit ratings and present a small risk of defaulting on their debt payments. It influences the lending rates for mortgage, personal loans, and credit cards.
Variable Rate Credit Cards
The increased rate primarily affects those with variable rate mortgages and home equity lines of credit, resulting in higher payments. Credit card holders will be affected differently depending on the type of cards they own. Consumers with fixed rate credit cards will not be affected by this rate hike. However, those with variable rate credit cards will most likely face increased monthly debt repayments. This is also the case with other financial products that carry a variable rate. Fixed rate credit card holders face some risk if they miss regular payments as the bank may raise the interest on outstanding amounts. This increase could be as much as 5% in some cases according to the Financial Consumer Agency of Canada.
According to the Canadian Bankers Association, the Bank of Canada rate represents less than one percent of bank funding and does not significantly affect the pricing of credit card interest rates. The five largest banks dominate the domestic credit card business with an estimated combined market share of 70-85%. A recent report by Moody’s suggests that a potential economic downturn could result in higher credit card losses at the Canadian banks. The booming housing market has fueled “unprecedented” levels of consumer debt. An increase in the key interest rate results in higher payments for servicing these debts. According to this report, people often neglect credit card payments in times of stress as homeowners prioritize mortgage payments. Credit card businesses may also suffer if people cut down on card usage or fall behind with their payments in an increased rate environment.
Will It Affect Your Credit Card?
Data from the Canadian Bankers Association indicates that credit card debt makes up only 5% of total household debt. Residential mortgage debt makes up 69% and line of credit another 18%. The CBA also reports that 58% of Canadians pay their credit card balance in full every month. Thus they avoid any interest payment, and credit card delinquency rate remains low at 0.87% as of April 2016. As such responsible credit card users would be unaffected by any changes in key interest rates or credit card rates. Any risk to the profitability of the banking sector due to a decline in the domestic credit card business may be overstated.