4 ways the U.S. Federal Reserve rate hike could affect Canadians

Markets had already factored in that the U.S. Federal Reserve would raise its benchmark interest rate today, economists say. Still, the hike in the key rate could affect Canadians.

The Fed boosted the target for the federal funds rate  a quarter-point — to 0.75 per cent from 0.5 per cent — the first increase in a year. (By comparison, the Bank of Canada recently announced it was holding its key rate at 0.5 per cent.)

"What the market is going to be watching is the language and some of the forecasts the Fed provides," says senior BMO economist Doug Porter.

1. What's good for the U.S. ...

The simple reason for the hike, says Nicholas Rowe, associate professor of economics at Carleton University, is that with the U.S. economy looking stronger, and the unemployment rate coming down, the Federal Reserve believes that if rates aren't raised, higher inflation becomes a risk.

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At the very least, the rate hike is "almost a stamp of approval on the recovery" by the Federal Reserve, says Porter.

"They're suggesting that they're confident enough in the recovery and things are close enough back to normal that they have the confidence to raise interest rates," he says.

The U.S. is a huge consumer of Canadian energy and exports. "If the U.S is doing well, it bodes well for [Canada] going forward," says Jean-Paul Lam, associate economics professor at the University of Waterloo.

2. Higher mortgage rates

The Federal Reserve interest rate affects long-term interest rates in both the U.S. and Canada, says Porter. An upswing in long-term interest rates has been one of the factors putting upward pressure on mortgage rates in Canada, he says.

"Nothing serious, but we have started to see rates broadly moving here for the most part, and the fact the Fed is back hiking interest rates is a big part of that," Porter says.

Rowe agrees that mortgage rates will rise in Canada as a result of the Fed's decision.

"How much? Well, don't sweat it yet," he says.

3. Pressure on the loonie

While mortgage rate increases could take some time to materialize, the hike in the Fed rate could have a more immediate effect on the Canadian dollar, says Lam.  

The hike will create more demand for the U.S. dollar and put pressure on the exchange rate, reducing the value of the Canadian dollar, he says. This will benefit Canadian exporters, but also make imports including food more expensive, Lam says.

"The fact that the Fed is back in the game has put a bit of downward pressure on the Canadian dollar or at least lifted the U.S. dollar against most currencies," Porter says. 

But Yellen's words today will be more important than the announcement of the actual rate hike, Porter says.

"If she's seen as being hawkish or tough on interest rates, that might lead to some softness in the Canadian dollar."

4. Savers vs. borrowers

While homeowners with mortgages like the low interest rates, Canadian savers, many of them retirees, have been punished by the returns they can earn with GICs.

And the reality is that the Bank of Canada is highly unlikely to raise its interest rates, which is probably the single most important driver for deposit rates, Porter says. 

"Something governor of the Bank of Canada Stephen Poloz made amply clear last week is that the bank is in no rush to follow the Fed's lead on that front."

But if U.S. interest rates are starting to move higher in a meaningful way, then there's at least a possibility that Canadian interest rates may follow along, says Porter. 

"I think there is some light at the end of the tunnel for interest rates if you're unhappy with very low interest rates. Of course, not everyone is. But for savers, it does suggest there's a flicker of light."