With recession risk, will banks be more cautious when lending money?

Justin Tang/CP

January 2007 was the month that many Canadian mortgage holders will never forget.

That was the month that Bank of Canada Governor Mark Carney announced it would be willing to cut borrowing costs once more in hopes of stopping the drop in home prices.

But that was then, and this is now. The latest Bank of Canada business outlook survey shows that a more uncertain economic outlook means business loans are going to be a lot harder to come by than they have been in the past.

“Our expectation is that over the next couple of years, interest rates will be higher than they’ve been in previous cycles,” chief economist Derek Holt says.

Help will not be available to keep business borrowing going at current rates, or at record low levels that are still supported by money-printing.

Mr. Carney says interest rates need to rise, because the global economy is stronger and Canada’s economy is in better shape than it has been in decades.

It is true that there is some level of risk — risk to the economy — if economic uncertainty just pushes borrowing costs higher. And yet there are also certain advantages if Canadians continue borrowing money at lower rates than they need to in the coming years.

They create more houses, giving local governments and other levels of government more to spend, and businesses have cash-flow issues that they can address by borrowing money on more favourable terms.

But there is also a chance that the economic environment will be even stronger than expected, and Canadians could find themselves needing to pay higher interest rates down the road.

“The big risk to the Canadian economy is whether we have a strong, export-led recovery that reaches (and exceeds) the government’s forecast,” Mr. Holt says.

If that turns out to be the case, Canada would have a responsibility to step in with low-interest rates to help businesses manage the debt that drives growth.

In the past, those low-interest periods have been remarkably short, and the last 15 years have been the most volatile in history — including some periods of steady interest rates.

There have also been periods in the past where the Bank of Canada’s benchmark rates were low for a long period, and then after a spike back up, interest rates would begin a long cycle of higher borrowing costs in which the Bank was seen to be helping dampen economic growth.

Bond markets are showing that confidence in the Bank of Canada’s ability to manage interest rates will be tested this year.

Investors see the central bank’s normalization of interest rates and its stress tests on banks as a sign that high risk-taking financial institutions are in the clear.

With inflation near the 2 per cent target, people have been investing money in longer-term securities rather than shorter-term ones, and that has weighed on short-term interest rates.

People also see an improving global economy, with the U.S. economy growing at 4.1 per cent last year, and two separate Canadian fiscal stimulus packages, one this year and one next year, providing employment and economic certainty.

So far this year, the Bank of Canada is sticking to its plan to raise interest rates, so don’t expect the rate rise to be a surprise. That’s why this more nervous tone in the Bank of Canada’s business outlook survey is not surprising.

Economists expect the bank’s rate will rise to 1.25 per cent in July, to 1.5 per cent by December, and finally 2 per cent by May 2019.

“The median of participants’ forecasts shows interest rates increasing over the course of 2018, a much more conservative pace of increase than before,” the report says.

There will be downward pressure from the Bank of Canada on low-interest mortgage rates, and, as the central bank also looks at the potential increase in rates, it has become more likely that this might happen.

For now, it would appear the Bank of Canada has more important things to consider — like a strong economy and housing affordability — as it contemplates its next move.

This story was produced by Postmedia Content Works on behalf of Bank of Canada for commercial purposes. Postmedia’s editorial departments had no involvement in the creation of this content.

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