May 15, 2015 by Greg Meckbach, Associate Editor
As some insurers struggle to maintain profitability with interest rates at a historic low, central banks in Canada and the United States will start to raise those rates over the next 18 months, but Canadians are “well insulated” against a surprise increase in interest rates, the Bank of Montreal’s chief economist suggested in a presentation Thursday to insurance professionals in Toronto.
“We think something very momentous is going to happen in interest rates this year,” said Douglas Porter, chief economist of BMO Financial Group, at the Centre for Study of Insurance Operations (CSIO)’s annual members’ meeting. “Arguably the most important interest rate in the world, the short-term interest rate in the U.S., we think, after more than six years of being effectively zero, is going to start rising later this year.”
He made his remarks after the formal portion of the CSIO meeting at the National Club, across Bay Street from BMO’s head office. Porter suggested to CSIO members that the total increase, in short-term rates in the U.S. will be about 1.5 percentage points between now and the end of 2016.
On April 29, the United States Federal Market Open Committee announced it had “reaffirmed its view” that the target short term interest rate of 0 to 0.25% “remains appropriate.”
On this side of the border, the Bank of Canada will wait until the second half of 2016 before raising rates, Porter suggested Thursday.
“So we see the bank on hold for more than a year now, and only then start quietly moving interest rates higher in the second half of next year.”
He added the U.S. Federal Reserve System “is slowly but surely laying the groundwork for the first change in rates since George W. Bush was president.”
In 2008, the fed “cut rates down to zero and there they have sat, and when you think about it, they cut them to zero in what was truly an economic emergency back in late 2008-2009,” Porter said.
Related Of Interest
But Canada and the U.S. are no longer in an economic emergency, he said.
“I think it really is a matter of time for them to start raising interest rates,” he predicted. “They are going to take this very slowly. They are going to be very deliberate and the last thing they want to do is upset financial markets.”
Porter (pictured below right) suggested the U.S. Federal Reserve System “will raise rates in September, and we think they will go at the pace of one-quarter (percentage point) per calendar quarter and we think they will maintain that in 2016, so that is a total rate increase of about 1.5 (percentage points) by the end of next year in the U.S.”
During a question and answer period, Porter alluded to the fact that in 1981, Canada Savings Bonds had rates of 19.5%.
“We had double digit inflation in the early 80s,” he said. “I do believe demographics are really a big factor here. The late 70s and early 80s is when the peak of the baby boom started to enter the labour force, started to buy homes, buy cars … there was a lot of new demand for borrowing and not a lot of demand for savings at that point.”
That spike in demand for loans 35 years ago “accentuated the rise in interest rates,” he said. “Now we are on the flip side of that. We now have a rapidly aging population. We have the early end of the baby boom getting into their late 60s, leaving the labour force.”
Although recent published reports indicate a concern about household debt (at about 160% of annual after-tax income in Canada), Porter suggested several countries – including Denmark, the Netherlands, Norway, Sweden and Australia – all have even higher levels of household debt.
“Canadians have done a very good job of consolidating that debt in mortgage debt,” he said. “Even if there was to be an interest rate surprise in the years ahead, I think households are typically well insulated against that.”
A lot of non-mortgage debt includes people making purchases with credit cards in order to earn points, Porter suggested.
“I think it has squeezed out a lot of so called bad debt, maybe higher cost debt,” he said. “When I see stories about people using their (home equity lines of credit) to build a swimming pool or buy a boat or something like that, it does concern me a little bit. There are some horror stories out there but when we look at the broader numbers I think Canadians as a whole have been relatively responsible.”