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On March 2nd, the Bank of Canada (BoC) lifted its policy rate for the first time since 2018, to 0.5 per cent, having kept it close to zero for nearly two years of the pandemic.
Earlier in the year, the bank indicated it would raise interest rates to slow surging inflation, which hit 5.1 per cent – a 30-year high – in January.
The central bank suggested that while global pressures would continue to push prices higher in the coming months, it would use its key interest rate to keep inflation expectations “well-anchored,” according to a statement. The Russian invasion of Ukraine was noted as a major new source of uncertainty, which is driving the price of oil and other commodities higher.
“This will add to inflation around the world, and negative impacts on confidence and new supply disruptions could weigh on global growth. Financial market volatility has increased,” the bank wrote.
There are certain factors to consider in an environment where interest rates may be rising. Understanding the relationship between interest rates and different types of investments can help you make better choices. Here are five points to keep in mind:
Guaranteed investment certificates (GICs): GICs have low risk attached to them. When you buy a GIC, you are depositing your money at a bank or financial institution for a pre-determined amount of time, ranging anywhere from several days to several years. In exchange, your money earns interest. The longer the term, the more interest you earn. When the term is up, you get the entire amount you deposited at the bank plus the interest that you earned. When interest rates rise, generally the fixed rates of interest offered on GICs do too.
Savings accounts:Saving accounts are well-suited for those seeking a higher rate of interest than a traditional chequing account, without having the need to lock in for a specified term. Similar to GICs, when the BoC raises rates, rates offered in savings accounts increase as well. This will come as a welcome change to savers who have been experiencing historically low interest rates due to the pandemic.
Equities: Equity (stock) prices may drop for a number of reasons, one being that companies now have higher borrowing costs and have to spend more to service debt. This means less money for capital investments, which can affect future earnings growth. Additionally, if consumers spend less due to higher debt levels and interest rates, corporate profits and revenues will fall. However, certain sectors (such as financial) tend to have a positive response to interest rate movements. A diversified portfolio is your best bet.
Bonds: Much like GICs, government bonds give you a fixed rate of interest and return your initial investment at maturity. These are more flexible than GICs because you can cash in your bonds at any time, although you may have to sell them at a loss. Government bond prices and interest rates generally move in opposite directions – when one goes up, the other goes down. A bond may yield higher when markets start to anticipate an increase in rates.
Margin accounts: A margin account is a brokerage account in which the broker lends the customer cash to buy stocks or other financial products. Simply put, a margin account lets you borrow funds to perform a trade. The funds are lent to you based on an interest rate that changes periodically. Because rising interest rates mean a rise in the cost of borrowing, this usually means you have to pay more to borrow against your existing investments.
Investment advice is provided by Royal Mutual Funds Inc. (RMFI). RMFI, RBC Global Asset Management Inc., Royal Bank of Canada, Royal Trust Corporation of Canada and The Royal Trust Company are separate corporate entities which are affiliated. RMFI is licensed as a financial services firm in the province of Quebec.
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.