How will a reduced key interest rate affect your finances?

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.

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

Find out how the FHSA can help you reach your savings goals, depending on your situation.

Everything you have in mind is possible, thanks to RRSPs, TFSAs and FHSAs.

Enter the contest

2. Decreasing returns for guaranteed investments: a good reason to enter the fund market

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

However, rate cuts can have a positive effect on financial markets. They often stimulate economic growth, which can boost investor confidence. Borrowing and credit costs are lower, businesses invest more and consumers generally spend more.

Depending on your financial situation and investment objectives, this period of lower interest rates could be an opportunity to diversify your portfolio and 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

Thinking about taking your first steps into the world of the stock market, but you’re concerned that market fluctuations could reduce the profitability of your investments? 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.

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