September 23

Interest Rates & Inflation

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Interest Costs

You’ve heard interest rates have increased, but what does that actually mean for your business?

First, let’s get you up to speed:

The Bank of Canada (BoC) on September 7, 2022, increased its interest rate in an effort to curb inflation. This is known as Monetary Policy.  This is the main way the BoC can control inflation as interest rates and inflation are usually inversely related. The BoC’s Prime Rate influences how banks set their own rates. These rates from banks are also known as the ‘Prime Business Rate’ and is what will directly affect you and your business. This is the rate used in different types of loans, lines of credit, and variable-rate mortgages. At December 31, 2021, the Prime Business Rate was set at 2.45% by all major Canadian banks until the first BoC’s increase on March 2, 2022.  Almost immediately upon announcement, banks increased their rate to 2.70% (the blue line in the chart below).

Increasing Rates in 2022

Since the first increase in March 2022, the BoC has increased its overnight policy interest rate from 0.25% to 3.25%. Throughout 2022, the BoC[1] has steadily increased its rate, with the Canadian banks following suit.

A line graph illustrating the rise in interest rates of selected products with time on the horizonal axis and percentage interest rate on the vertical axis.
Interest rates for selected products by major chartered Canadian Banks

Increasing Rates, Increasing Costs

So how does this affect businesses? We’ll use 5 year conventional mortgages as our example. The 5 year conventional mortgage rate is now 6.14% at most major Canadian banks as compared to 4.79% as at December 29, 2021.  It is illustrated as the red line in the chart above.  Let’s say, your business borrows $500,000 to buy new machinery, your condo in the strip mall, or to invest in new software development.

A table showing a comparison of the total interest cost of debt between a loan with 4.79% and a loan with 6.14%
Total Cost of $500,000 5-year Conventional Mortgage, Paid Monthly Amortized over 25 Years

With the increase in the interest rates in 2022, the business will now have to pay $33,000 more by the end of the 5-year term and over $120,000 more over the entire 25-year amortization period of the loan.  In each year, the business will pay this increased dollar cost of interest as a result the increasing interest rates. 

A line chart illustrating the cost difference in the annual cumulative cost of interest of a loan using two different interest rates.  The value of total interest paid is on the vertical axis and time is on the horizontal axis.
Total cost interest cost of a $500,000 conventional mortgage for a 5 year term, paid monthly, amortized over 25 years.

Inflation steals purchasing power

But let’s not forget the inflation that is causing these increases. Inflation is the decrease in the purchasing power of a currency. Prices for supplies, services, and wages have all also increased cutting into profits or cash on hand. Small businesses will need to make strategic moves handling inventory levels, staff, and their debts.

Businesses should prepare for any further increases which are likely to come.


[1] https://www.bankofcanada.ca/rates/banking-and-financial-statistics/posted-interest-rates-offered-by-chartered-banks/  Sep 23, 2022


Tags

business value, Interest rates, Money


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