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rob carrick

This is the thin edge of the interest rate wedge.

The Bank of Canada nudged up its trendsetting overnight rate by one-quarter of a percentage point Tuesday and said it's in no hurry to raise rates further because of global economic uncertainties. It's quite the soothing message for people who are up to their eyeballs in debt, and it should be ignored.

There may not be a staccato burst of rate increases in the months ahead, but higher rates are coming. The question is when, not if.

The Canadian economy is performing brilliantly right now, so much so that economic growth in the first quarter of the year came in at an incredible 6.1 per cent on an annualized basis. Inflation's not a problem yet, but it's also not benign. On the whole, we have an economy that could probably use a tap or two on the brake pedal to keep it under control.

But while everything's humming along here in Canada, some other parts of the world are struggling to the point where governments are in danger of defaulting on their debts. That's why the Bank of Canada seemed almost halfhearted about Tuesday's rate increase, and why it said any further rate increases would have to be considered carefully.

Yes, the global economy is quite the mess in spots right now. But rates will go up here in Canada, and that's not just idle forecasting. It's history talking.



An Investor's Guide to Understanding the Economy by Gary Rabbior:

  • Part 1: How the money in the economy is managed
  • Part 2: How inflation works
  • Part 3: Avoiding the deflationary spiral
  • Part 4: How much money is too much money?
  • Part 5: How markets and currencies work
  • Part 6: How interest rates affect your investments


Let's use some decade-long data for the major banks' prime lending rate as a gauge. As the Bank of Canada's overnight rate goes, so goes the prime and, in turn, products that are priced off the prime - like variable-rate mortgages and lines of credit.

The prime rate has averaged 4.8 per cent since Jan. 1, 2000, which compares with today's rate of 2.5 per cent, which reflects the Bank of Canada's latest move.

Don't take too much comfort from this average because it has been heavily influenced by the plunge in interest rates that began as the financial crisis bit in 2008. In fact, prior to the crisis, the prime rate spent the better part of two years above 6 per cent. At the beginning of the last decade, the prime rate spent close to a year at 7 per cent or higher.

There most likely won't be a sudden surge to levels that high. Instead, you'll see the central bank kick up rates by one-quarter to half a point now and again. Quarter-point increases suggest a cautious gradual approach, half-point increases tell you the bank means business.

The next rate-setting date for the central bank comes July 20. If rates stay put, then mark down Sept. 8, Oct. 19 and Dec. 7 on your calendar. Those are milestones for easing yourself out of the easy-money mindset we've lived in since rates starting falling in late 2007.

Here's how you do it. First, you cap current borrowing. No more dipping into the line of credit, no more refinancing the mortgage, no loans, no leases and no credit cards unless you can pay in full immediately. Second, you marshall any available cash to pay down what you currently owe. Did you get a tax refund this year? Then this is an ideal place to spend it.

A third step is to look at your household budget to find cash you can reallocate to higher interest payments in the months and years ahead. Pay raises may help, if you're getting one any time soon. If not, then ask yourself how you might cover off the extra few hundred dollars you'd need to pay if the rate on a $250,000 variable-rate mortgage, taken out at today's rates, were to eventually double.

With household debt at record levels, it's appropriate that rising rates are seen in a bad light. But for seniors and others with minimal debt and a need to earn a decent rate of return on conservative investments, rate increases will be a welcome relief.

Patience is required, though. High-rate savings accounts should be the first to benefit from Tuesday's move by the Bank of Canada, and money market funds may get a mild bump as well (they're earning close to nothing now).

Returns from bonds and some guaranteed investment certificates have actually dipped recently, but that's only because of the weakness in the stock market. Once the focus returns to the stronger economy and the risk of inflation, bonds and GIC rates will start to rise.

After months of chatter about rising interest rates, the latest developments seem almost inconsequential. Stay ready because they're only the thin edge of the wedge.

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