It will take very little time for many Canadian borrowers to feel the effects of the first rate hike in seven years.
After the Bank of Canada raised its key overnight lending rate by 25 basis points – a quarter of a percentage point – on Wednesday morning, the country's largest banks quickly followed suit. By the end of the day, the Big Six banks had all raised their prime lending rates to 2.95 per cent from 2.7 per cent, effective Thursday. As the basis for most variable loans, the higher prime rate will immediately result in additional borrowing costs on products like variable-rate mortgages, home equity lines of credit, and other credit lines.
The domino effect of rate hikes could become a familiar theme in the months ahead as further potential rate hikes put scrutiny on overly indebted Canadian borrowers, many of whom could be tested by higher interest costs. For banks, the rise in rates will help boost profits earned on loan portfolios by providing better margins.
"Borrowers should be prepared for rates to continue to push up toward historic norms," said James Laird, co-founder of rate-comparison site RateHub.ca. "We're still in an abnormally low interest-rate environment."
Meanwhile, Canadian savers with little debt who are hoping to finally start to earn decent returns on savings may have to continue to be patient. Returns on deposits not linked to prime rates are typically much slower to respond to a rising rate environment, Mr. Laird said.
"They're much quicker to pass along the hike when they're the ones collecting the interest, rather than when they're the ones paying it."
That appears to have been the case the last time the Bank of Canada raised rates.
Starting in June, 2010, three successive 25-basis-point rate hikes lifted the overnight lending rate from emergency levels brought on by the global financial crisis.
As the Bank of Canada rate rose to 1 per cent from 0.25 per cent, Canadian banks hiked their prime rates in lockstep. But the returns on guaranteed investment certificates remained just where they were through the rest of the year, averaging below 2 per cent, according to Bank of Canada data.
The course of rate policy in 2010 was ultimately interrupted by renewed weakness in the global economy, including the European sovereign debt crisis. Then the oil price shock beginning in 2014 forced Bank of Canada governor Stephen Poloz to again cut rates.
Now, once again the domestic economy has improved enough to justify a reduction of monetary stimulus. While Wednesday's rise of 25 basis points still leaves rates at ultra-accommodative levels from a historical perspective, Canadian borrowers have grown unaccustomed to rates moving upward, Mr. Laird said.
"In 2010, [the hikes] didn't feel shocking, since we had just seen some crazy moves on the way down, getting to all-time lows faster than anybody expected. Now, seven years later, the market has gotten used to these rates. So today's rise feels a little more jarring."
After announcing the hike on Wednesday, the central bank acknowledged that the economy may be more sensitive to higher interest rates than in the past given the country's amount of household debt. Canadian households owed $1.67 in debt for every dollar in disposable income at the end of last year. Since 2009, when the housing boom started, total household debt has risen more than 50 per cent to $2-trillion and mortgages account for about 66 per cent of that, according to Statistics Canada.
"We will need to gauge carefully the effects of higher interest rates on the economy," the central bank wrote.
Higher interest rates are good for banks, which profit from the difference between the interest they charge borrowers and what they pay to savers.
So while prime rates generally move in tandem with the central bank's benchmark rate, in 2015, when the Bank of Canada cut its overnight rate by 25 basis points twice during the year, most banks responded by cutting their primes by just 15 basis points.
Passing through the full hike will help boost the banks' margins.
With a file from Reuters