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BoC says Low Interest Rates Big Risk, but will Keep Them Low

8 December 2012

A lot of people have criticized Mark Carney and the Bank of Canada for keeping the interest rates at near rock-bottom lows, then turning around and warning us all about taking on too much debt. But amid the cries of some, pleading with the central bank to raise their rates, the bank has not gone oblivious. They know what those rates are doing. And they know the risks they pose. They even came out and said so this week.

In its semi-annual financial systems review, issued on Thursday, the Bank said that the low interest rates were posing a major risk for pension funds, life insurance, as well as consumers and those piling too much debt into their home.

“The low interest rate environment in major advanced economies represents another risk to the financial system, both in Canada and globally,” the review said. “The risk involves increased vulnerability for financial institutions with long-duration liabilities (life insurance companies and pension funds,) and increased incentives for excessive risk taking in a search for yield, which could distort the pricing of both real and financial assets.”

The bank did mention that while risk for these institutions is currently moderate, it’s also increasing. And that could spell trouble.

“Evidence of excessive risk-taking behaviour by pension funds and life insurance companies, and in global financial markets more generally, remains limited, although there have been some indications that investor tolerance for risk is increasing.”

Right now, according to the report, insurance companies are at risk because those low interest rates are providing a much lower yield than had been predicted. And while when it comes to trouble at the banks and financial meltdowns, we can typically look on our neighbours south of the border with wrinkled noses, that’s not the case this time. Because our banks are held to much higher standards when it comes to their accounting practices, it’s banks within this country that are actually much more at risk.

And those low interest rates that are returning low yields are also the same things that are putting pension funds in jeopardy. This is because, as stated in the report, “as long-term interest rates decline, the present value of the plans’ future liabilities increases.”

But despite this increase, the Bank’s hands are virtually tied. Were they to increase rates now, just after the housing market has begun to cool due to the mortgage rules and new OSFI rules, it would devastate the market. That in turn, would most likely have an effect on the construction industry, the employment sector in general, and the overall economy.

The fiscal cliff and other global concerns, while all showing positive signs of recovery, are also reasons Carney gave last week in this last interest rate announcement.

“The economic expansion in the United States is progressing at a gradual pace and is being held back by uncertainty related to the fiscal cliff,” Carney said at the time. “Although underlying momentum appears slightly softer than previously anticipated, the pace of economic growth is expected to pick up through 2013.”

And while a boost to the economy is always a good thing, don’t expect interest rates to rise because of it. Economists have largely predicted that Carney will keep the rates where they are until he departs to the Bank of England; and that his successor will most likely continue to hold rates where they are.

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