BoC Lowers Economic Outlook: Response by Robert Ironside

This week's announcement by the Bank of Canada that it expects to hold its key policy interest rate (also referred to as the "target for the overnight rateî) at 1% for a protracted period of time confirmed what many people already thought to be true ñ the global economy, including the Canadian economy, is still struggling to recover from the economic contraction of 2008-2009 and the odds of a double dip have increased.

What does this mean for financial advisors and their clients? First, the struggle to find positive rates of return continues. For the risk adverse client used to buying GICs and T Bills, the news is dismal indeed. Today's low interest rates are likely here to stay for at least another year, maybe more. This is creating a real strain for many seniors who don't want to dip into their capital but who are being forced to because of the extremely low yields available in the market.

From a planning perspective, it also throws into question the correct assumptions about an appropriate real rate of return to use on a go forward basis. The lower the real rate of return, the more money people have to save to ensure they have sufficient capital prior to retirement. For example, if a retiree wants $5,000 a month of actual purchasing power for a 25 year retirement and real rates are expected to be 5%, they need to have saved $855,000 as of their retirement date (assuming they will exhaust their capital at the end of the 25 year period). However, if real rates are only 2%, they need almost $1,200,000 of savings. And with today's real rates hovering around 1%, they would need about $1,327,000 of savings.

Unfortunately, the problem doesn't end there. High real rates prior to retirement make the process of saving for retirement easier. With today's extremely low rates, much more of the heavy lifting has to come from actual savings and much less can be expected to come from compounding within the portfolio.

As if this were not enough, the final problem is the rapid rate at which Canadians are piling up debt. Induced to take on more debt by today's extremely low interest rates, the average individual in Canada has debt equal to 146% of disposal income, which is approximately equal to the debt carried by US citizens prior to the meltdown of 2008/2009.

However, whereas the US consumer has rediscovered the virtues of thrift and the value of saving money, Canadians are continuing to add to their debt loads at a rapid pace. When interest rates eventually start to normalize, the increased burden of carrying this debt will reduce their ability to spend on other goods and services, potentially putting a drag on Canadian growth rates for several years in the future. Advisors will want to cover these two points with their clients.