The Bank of Canada has raised the benchmark rate to 1%. Does that mean the Bank of Canada is optimisic about the Canadian economy despite some bad news we are haering about the slowdown of the European and the U.S. economy? Is it a signal that the so called exit strategy is near upon us?
The main impetus behind the Bank of Canada's hard to swallow decision is the growth of consumer debt. Canada is one of few countries that has not participated in deleveraging since the 2008 financial crisis. Canada's consumer debt level is now sitting at around $40,000 per capita in 2009, twice as much as it was in 2001. This partially explains the great real estate run Canada has experienced for almost a decade. For a year or so, the Bank of Canada has raised concerns about the increasing level of debt, and by increasing the benchmark rate, the Bank will try to induce people to take on less additional debt and start paying off debt to avoid painfull consequences of collapse of asset bubble. In conclusion, the BoC action is rather induce households to start paying off debts rather than taking on more debts. BoC's dillemma is if it raises interest rates too high too fast, many of the households will have to take on higher financing costs on their debts.
