The Bank of Canada (BoC) meets eight times a year on a pre-set schedule to determine if any adjustments are required to the key policy interest rate. The BoC typically reduces the policy interest rate when they believe that inflation is well-controlled and monetary policy is too restrictive. Cutting the interest rate makes saving less attractive and will encourage individuals and businesses to spend, which supports economic growth.
A central bank rate cut is typically bad news for savers, who are individuals who have a high allocation to cash and cash equivalents (including money market funds, high interest savings accounts and Guaranteed Investment Certificates (GICs)). An interest rate reduction means that savers will earn less interest on deposits in interest-bearing accounts and receive lower rates offered on GICs at renewal.
A central bank rate cut can benefit investors with bond and equity market exposure. Individuals who have their investment portfolio primarily allocated to fixed income and equity securities (including mutual funds, ETFs and individual stocks and bonds). An interest rate reduction helps support equity markets because business will benefit from lower borrowing costs. They can use borrowed money to reinvest back into their business or hire more employees. The resulting increase in economic activity will also help maintain profit margins. Bond holders also benefit because new bonds that are issued will be done so at lower rates, making the existing bonds with higher rates more attractive, driving up the price.
This chart shows that on average, Canadian stocks and bonds have outperformed cash following 12 months after the first Bank of Canada rate decrease.
This chart shows that on average, Canadian stocks and bonds have outperformed cash following 12 months after the first Bank of Canada rate decrease.
A lower expected return due to a higher allocation to cash can open the door to not meeting your financial goals.
While a Bank of Canada rate decrease is signal that the economy needs support, financial markets are forward-looking and tend to react positively in this environment.
For individuals with variable-rate debt like a line of credit, a central bank rate cut is generally good news. Variable rate debt is tied to a bank’s prime lending rate, which is adjusted accordingly when central banks change the policy interest rate. An interest rate cut may or may not impact your payment, but it should impact how much of your payment goes towards the principal balance, which could result in you paying off your outstanding debt sooner.
For those who are looking to renew or finance a new mortgage, a Bank of Canada rate cut can also be beneficial. Mortgage rates are positively correlated to Government of Canada bond yields. When interest rates are going down, bonds yields tend to fall and so do mortgage rates.
With cash and cash equivalents earning less interest, and borrowing rates coming down, an Edward Jones advisor can help you weigh the benefits of holding excess cash versus investing or reducing debt. We recommend you review your portfolio at least annually to ensure you're on track to meet your goals.
