How will a reduced key interest rate affect your finances?
Make the most of falling interest rates to reduce your debt and grow your savings!
Cuts to interest rates cause shifts in the markets. Find out the 3 effects that lower interest rates could have on your savings.
When the Bank of Canada announces a cut to its key interest rate, it often means some welcome financial breathing room for Canadian families. A lower rate can also give the economy a boost.
With the goal of keeping inflation stable while promoting growth, central banks adjust their monetary policies based on how the economy evolves. Typically, interest rates rise when inflation is too high and fall when inflation approaches the central banks’ 2% target. Inflation is measured using the Consumer Price Index (CPI).
If experts anticipate a series of rate cuts in 2024, favourable investment opportunities may arise. That's because interest rate cuts have a direct effect on the cost of borrowing and returns on certain investments. What’s more, falling interest rates can also push markets in a positive direction.
- What are the effects of these cuts on prevailing interest rates and your portfolio?
- What investment strategies should you consider in such an economic climate?
To fully understand how falling interest rates affect your savings, let’s look at how economic growth and inflation are connected.
The link between monetary policy and inflation
The economic cycle directly influences inflation, particularly during periods of growth.
| Strong growth and low inflation | Strong growth and high inflation | Weak growth and high inflation | Weak growth and low inflation |
|---|---|---|---|
| The economic cycle begins with robust growth but low inflation, leading to the return of inflation. | Economic growth and high inflation. Central banks raise interest rates. | Growth slows. Central banks keep interest rates high to control inflation. May lead to recession. | Final phase when growth and inflation are low, generally during a recession or as the economy emerges from recession. |
Historically, interest rates fall when we enter the last phase of the economic cycle—the “weak growth, low inflation” phase. This period of falling interest rates is intended to stimulate economic recovery.
Lower interest rates and three potential effects on your savings
1. Reduced variable-rate debt: more money to invest
When your financial institution offers a lower rate, it can reduce the pressure of your variable-rate debt, such as:
- Mortgage
- Personal loan
- Home equity line of credit
Better mortgage rates for homeowners
Good news! If you have a variable-rate mortgage, any cut to interest rates will immediately lower your mortgage payments.
If, instead, you have a fixed-rate mortgage, your payments will remain the same, but you may be able to lock in a better rate when it comes time to renew or refinance.
Welcome relief for those who have taken out a loan
As banks lower their interest rates, you may find your financial health improving and your financial stress—which may have taken a serious toll on your day-to-day life—beginning to melt away.
According to the Financial Consumer Agency of Canada, close to one in two Canadians reports losing sleep over their finances. It’s not uncommon to worry about debt or being unable to invest enough money in your TFSA, RRSP or RESP. And the positive effects of reduced financial stress don’t stop at your physical and mental health; the effects are felt across:
- Your relationships with loved ones
- Your productivity at work
- Your confidence in managing your finances
2. Reduced returns for guaranteed investments: securing a GIF rate
A reduced key interest rate will also have a downward effect on the return on guaranteed investments, which are directly influenced by interest rates.
- Investments in a high-interest savings account (HISA), which offers a variable rate, could see diminished returns
- Guaranteed interest fund (GIF) rates are also likely to be trimmed down
Consider this:
It could be strategic to play it safe and invest in one or more GIFs now to take advantage of higher rates before they fall. That way, you can maintain your current yields, which will provide some stability and better balance your portfolio.
Depending on your situation, this could be yet another reason to gradually enter the fund market!
3. The rising value of bonds: seize the opportunity
A falling key interest rate creates a favourable environment for bonds, since their yield is directly linked to prevailing interest rates. When interest rates are adjusted, bond prices change—tending to fall when interest rates rise and vice versa.
This is because existing bonds have higher rates than new bonds, making them more attractive to investors and driving up their price. This is also why, during periods when interest rates are falling, the value of bonds with longer-term maturities increases more than the value of short-term or variable-rate bonds.
Limiting risk with segregated funds
Are you interested in taking the jump into the stock market, but are worried about volatility reducing the profitability of your portfolio? Because they limit risk and protect your savings, segregated funds could be an interesting option for you.
Segregated funds are made up of equities, bonds or money market securities. They’re similar to mutual funds but have the big advantage of providing insulation against market downturns by guaranteeing 75% to 100% of the invested amount at maturity or death. If you’re interested in learning more, talk to your financial security advisor. They will recommend funds that suit your investor profile.
Make the most of falling interest rates to reduce your debt and grow your savings
A decrease in the key interest rate and preferred rates directly impacts your purchasing power and ability to save. New investment opportunities could allow you to take advantage of this situation by boosting your returns.
Remember, no matter how the markets are behaving, it’s essential you diversify your asset portfolio. Bonds and guaranteed investments are interesting and complementary options that help offset risk and protect your money.
Contact your financial security advisor today to develop an optimized investment strategy, based on the current market and your most up-to-date investor profile.
To make sure you’re not missing out on any of the latest business news, check out our podcast, In Your Interest!
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