Interest Rates & Investments: Understanding the Impact

There is a reason why so much time on financial news shows is spent behaving as though every sneeze that takes place within the Bank of Canada is as thrilling as a Harry Potter novel. This is because the Bank is responsible for setting what’s called the base rate — which is the government set interest rate at which banks loan money to one another. Any tiny movement of this rate will have a massive rippling effect through the economy — and major effects on your investments.

There are a number of reasons why this is. When the Bank of Canada raises rates it does so in order to control inflation by effectively limiting the supply of money circulating in the economy. By doing this it will cost everybody — including public companies — more to borrow money. If it costs companies more money to borrow money to expand their businesses, they might either slow their expansion or be forced to spend extra money servicing loans. Either of these scenarios might negatively affect their corporate earnings, causing the share price to fall. If enough companies’ share prices falls, you’ll see overall lowering of major stock market indices like the S&P/TSX Composite Index. (From a stock perspective, rate hikes are only welcome news for bank stocks, since banks will inevitably benefit from the increased revenue that comes with higher interest rates.) When interest rates rise, the economy usually slows down as well, since some of the consumers who might otherwise blow their money on Bali vacations and Maseratis have to use that money to pay higher mortgages.

Conversely, when the Bank of Canada cuts the base rate, money to borrow is more readily and cheaply available, stocks tend to rise, and consumers celebrate by making it rain wherever they go. For reasons that are exhaustively spelled out here, rising interest rates also drive down the prices of existing bonds, while falling interest rates conversely push them higher.