Why Chrystia Freeland should be nervous about rising interest rates

Inflation and borrowing practices need to be addressed

With inflation in Canada soaring to 5.7% in February — a 30-year high — many economists agree it was well past time for the BoC to act.

The main way central banks fight inflation is by raising interest rates. Benjamin Reitzes, managing director, Canadian rates & macro strategist for BMO Capital Markets, says all the signs showed a hike was necessary.

“Above all else, inflation — the Bank of Canada targets 2% inflation — and we are well above that. And the economy is operating at capacity,” says Reitzes. “You put all that together, and we’re well beyond the time where the economy needs very stimulative interest rates. It's time to push rates higher.”

Reitzes says this particular hike, which is the second of six expected over 2022, shouldn’t significantly affect households — unless they’re carrying significant debt.

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But what it should impact, he adds, is borrowing practices.

“It's possible there is some borrowing or lending that may not be fully responsible that's gone on over the past year or so,” says Reitzes. “And there could be some necessary belt tightening on the back of this.”

As for Finance Minister Chrystia Freeland, does Reitzes think she might be nervous about rising rates?

“I hope so,” says Reitzes. “We've been through a really long period of very low interest rates ... and that should make the government a little bit more conscious on spending … It's time to rethink the way they spend their money, which should always have taxpayers in mind anyways.”

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Debts are about to get heavier to carry

At the end of March 2021, Canada’s federal debt stood at $1,048.7 billion, a record high.

“All this debt that's been accumulated is going to hurt,” says Bernard Wolf, professor emeritus of economics and international business with the Schulich School of Business at York University in Toronto.

Freeland herself is clearly conscious the piper will eventually need to be paid. This year’s budget aims to run with a reduced deficit of $52.8 billion, compared to $144.5 billion in the previous fiscal year.

“Our ability to spend is not infinite,” she said in the House of Commons while announcing the budget. “We will review and reduce government spending, because that is the responsible thing to do.”

Some Canadians may think that sounds like a problem for Freeland to sort out, not them. But unfortunately, Wolf explains, if spending continues at the rates we saw during the pandemic, the government will eventually need to find money elsewhere.

“Something has to give and probably taxes of various kinds [would] go up.”

That, or the government will find itself with less money to allocate to social programs and services.

However, both Wolf and Reitzes emphasize that when it comes to these situations, the effects of rising interest rates on a heavy federal debt load aren’t felt overnight. Reitzes hesitates to offer a timeline of when its effect would trickle down, stating that it could take years to impact consumers.

“We only refinance a small part of the debt on an annual basis so it's not as if it's going to see an immediate impact on anything,” he says. “Over time, it is something that governments need to keep in mind, and if it grows sufficiently, then it can start to restrain spending.”

Where it will go from here

As the Bank of Canada moves toward quantitative tightening, the federal government’s 2022 budget aims to make life more affordable for average Canadians.

But many of the government’s new programs will take years to accomplish that goal. For now, with inflation still creeping up and interest rates on the rise, it’s hard to know what the coming months or years will hold for Canadian consumers.

“It's very much in flux what the next 10 years are going to look like and so it's … more of a wait-and-see environment than anything else,” says Reitzes.

And with each spending choice, Freeland and policymakers have to choose what not to prioritize. Which means for those average Canadians, whatever the government does to reduce its deficit, they’re sure to feel it eventually.

“It doesn't really matter whether you are spending less, or you're raising money by taxation,” says Wolf. “Either way, the consumer … is going to have less.”