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Are Canadian Banks Setting the Country’s Interest Rate Policy?

When it comes to economic policy, many people believe that big business – particularly the large banks – have an undue influence that they manage to wield to their advantage. One need only google “Goldman Sachs Conspiracy” to read all about the supposed “shadow government” controlled by the venerable investment firm. Nevertheless, events transpiring in Canada this week hint that even the country credited with having the world’s “best” banking system [1], may also have its share of power brokers calling the shots behind the scenes.

Now I enjoy a good conspiracy theory as much as the next person, so with tongue somewhat-planted-in-cheek, let’s see take a quick look at the buzz arising from this week’s announcement that Canada’s major banks [2] are raising mortgage rates. This move was completely unexpected by most people as the Bank of Canada [3] has kept the overnight lending rate at 0.25 percent; in fact, Bank of Canada Governor Mark Carney [4] recently reaffirmed his earlier pledge that, barring unforeseen circumstances, the bank would hold the line on interest rates until next summer.

It is this pledge that is causing Carney and the Bank of Canada some anguish. Canada is showing positive signs of emerging from the recession – employment rose by some 36,000 jobs last month and retail spending is also on the rise, but there is still sufficient weakness to warrant the current lending rate. However, Canada’s housing market – particularly in the major urban centers of Toronto and Vancouver – is positively red hot. Ultra low mortgage rates have helped open the flood gates and home prices are rising so quickly on the growing demand, that insiders are starting to worry that Canada could be on the verge of a sincere and truthful housing bubble.

Meanwhile, the Canadian dollar – or “the loonie” as it is known – is racing towards parity and beyond, having gained nearly 20 percent on the US dollar in the past three months. With the United States buying up to 80 percent of Canada’s exports, the last thing the Bank of Canada wants to see is a swing in exchange rates making Canadian products even more expensive for its number one customer just as the Canadian economy is returning to positive growth. This makes the prospect of raising the overnight lending rate downright distasteful for the Bank of Canada as this would surely increase demand for the loonie, pushing it even higher on the currency markets.

Enter Canada’s retail banks, who with one simple announcement, have solved Carney’s immediate interest rates problems while at the same time, calling into question just whom exactly sets interest rate policy for the country. By bumping up mortgage rates, Canada’s banks have provided the dampening effect that many feel is necessary to calm the housing market; this also enables the Bank of Canada to keep its promise of maintaining the current overnight interest rate for at least a little while longer. If this means that Canada’s commercial banks can make a little extra profit – it’s win – win for everyone. Well, just about everyone. If your mortgage is, like mine for instance, due for renewal in January, you would be hard-pressed to see yourself in a winning situation.

While Governor Carney may not have instructed the banks to raise mortgage rates, given the bind in which the bank of Canada finds itself, I am quite certain that he is not displeased.

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Scott Boyd

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