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Bank of Canada interest rate reduction is a significant move

Bank of Canada interest rate reduction is a significant move

July 23, 2015

The Canadian economy is not as strong as many of us had assumed. Last week’s lowering of the interest rate by the Bank of Canada will have a ripple effect for many.

The financial news that has gripped headlines over the past months has been the financial woes of the Greek economy. By contrast, we felt our financial base was sound.

Not so. Last week Stephen Poloz, Governor of the Bank of Canada, lowered interest rates in order to accelerate growth in the slowing Canadian economy.

The central bank decreased the overnight interest rate by one quarter of a percentage point to 0.5 percent. This is the second interest rate reduction this year.

One of the ways the central bank controls the Canadian economy is by setting interest rates. When the economy starts to falter an interest rate reduction is designed to fuel growth.

There are three reasons why the Canadian economy has slowed. Oil prices are down, the Chinese economy has slowed, and the Canadian manufacturing sector is not performing as well as has been anticipated.

The Bank of Canada’s interest rate reduction is significant, as is its ripple effect.

The Bank of Canada is running out of flexibility to reduce rates in the future. The current overnight interest rate of only 0.5 percent does not leave the bank much room to reduce it further.

Eliminating the ability to reduce rates in the future will be a game changer for the central bank. Historically the ability to lower rates has been one of the best ways to accelerate the rate of growth in our economy.

That is a big risk. Also a big risk is that lower interest rates will encourage Canadians to accumulate even more debt.

Many think that the historic high levels of personal household debt is a ticking time bomb for the Canadian economy.

Greece has too much debt. So does Canada.

Lower interest rates mean those retired will have less income from their fixed income investments. Many people count on interest income to help them pay their bills in their later years.

Many will be motivated to put more of the investments in stocks or mutual funds that own stocks. Stocks perform better over time; however, normal volatility can scare many to sell at the first sign their investments decline.

Timing the market with panic decisions means you lock in declines by selling. The evidence shows that many individuals do not have the discipline to invest in stocks.

And finally there are political implications of the economy slowing. The current Conservative government has boasted about its financial expertise.

We are headed to a fall election and Canadians will judge the government on results. Forget about the bottom falling out of the oil market.

Voters will be angry if all is not well with the economy.

Last week’s lowering of Canadian interest rates is a warning to us that there is financial risk ahead with the Canadian economy.

We encourage you to anticipate how a downturn in the Canadian economy could affect your personal financial situation.