Investors expect the next rate increase cycle to be stronger than the previous four. How to prepare yourself for higher interest rates?

As the spending levels are growing in Canada and households have been saving extra cash, investors expect the central bank’s next rate hike cycle (it may start in 2022) to bring interest rates above the previous peak for the first time in many years.

During the four major tightening cycles since the early 1990s, the Bank of Canada’s key lending rate was up to a level lower than the previous peak. However, it can change over the next cycle, as massive government spending globally increase the possibility that an economic recovery from the COVID-19 crisis will be stronger than the previous ones.

The Canadian government spends $101-billion (almost 5% of GDP) for stimulating the national economy over three years. Meanwhile, the U.S. President Joe Biden has proposed trillions of dollars for infrastructure spending. Canada sends approximately 75% of its exports to the U.S.

A higher peak for rate hikes may provide the BoC with more powers to fight the next slowdown. It could also lead to certain economic changes, raising the desire to save and invest rather than borrow. As you know, Canadians have been borrowing heavily, trying to enter one of the world’s hottest real estate markets.

The central bank has made it clear the rate increases will begin in the second half of 2022 – even earlier than in case of the U.S. Federal Reserve, which plans to do it in 2023.

According to swap market data, the peak of the expected cycle may reach 2% in five years, outpacing the previous peak of 1.75%.

“We can see a lot more fiscal policy this time, and it changes everything,” – noted Andrew Kelvin, chief Canada strategist at TD Securities. “During the previous cycle, Canada was part of a global cycle where no central bank achieved what they could call the neutral rates.”

It’s important to explain that the neutral rate is the level expected when the economy is at full strength and inflation coincides with the target level. It points to where rates may go. Today, the BoC’s neutral rate varies from 1.75% to 2.75%.

The Bank of Canada says Ottawa’s support for households combined with lower spending by Canadians over the long lockdowns raised savings last year by almost $180-billion.

That extra money will probably increase consumer spending during the next 10 years, bringing a terminal rate higher than not only the previous cycle peak but even than the neutral rate, believes Royce Mendes, a senior economist at CIBC Capital Markets.

“At some point, all that money has to go somewhere,” – Mr. Mendes said. “It’s not going to stay in the bank accounts for decades.”

If you have stable job and recently got a mortgage at the ultra-low rate, today is the perfect time to start preparing yourself for the future rate hikes. The easiest way is to increase your regular mortgage payments and bring them in line with a potential higher rate. Let’s say you have variable rate mortgage at Prime-1% which is currently 1.45% or you’ve got any fixed rate lower than 2%, call your broker or bank and ask them to calculate your payment at 2 or 2.5% and if you are comfortable with the new payment – set it on this level (most lenders allow you to increase your regular payments by 15-20% annually). Any extra amount will go directly toward your principal and when time comes for rates to rise you will be paying higher interest on smaller mortgage balance.  If this scenario is a bit hard on your budget, try to switch to bi-weekly accelerated payments, basically paying 1 extra monthly payment per year, but this way it’s a bit easier to manage.

If you own a property and have any unsecure credit card debts or loans – consider refinancing your mortgage and include high interest debts into one low rate mortgage. You might be surprised how much cash you can free-up and use it to pay your mortgage faster or significantly improve your cash-flow and start breathing easier without high interest credit cards burden.  Consult with your mortgage broker or bank first to find out potential penalty on your existing mortgage and run the proper calculation.