How an 80-Cent Dollar Helps Canadian Banks, Sort Of

With the recent rate hike by the Bank of Canada in every investor’s rear-view mirror, the entire Canadian market is looking forward to what future rate hikes may be in store, as investors look to revise their discounted cash flow models up or down depending on how they believe a given sector will react to interest rate hikes moving forward.

Assuming that additional rate hikes will come (the market is currently pricing a probability of more than 70% of an additional rate hike before the end of the year), it stands to reason that a 1% benchmark rate will make Canadian investment sufficient for investment to pick up, encouraging domestic lending and improving lending margins for Canada’s biggest banks.

Of the largest Canadian banks, the most prominent or often-cited bank for investors to look at as a benchmark for the Canadian banking sector is Royal Bank of Canada (TSX:RY)(NYSE:RY). Royal Bank, like all other major Canadian banks, stands to gain from such hikes moving forward as lending spreads widen and the domestic economy improves (rate hikes are generally considered to move in lockstep with domestic economic performance).

That said, it remains unclear how well the Canadian economy is actually doing, as persistently low inflation has plagued the recession recovery substantially in recent years. Should raising rates negatively impact Canada’s major GDP-generating economic sectors, RBC and other large Canadian banks could be hurt in the long-run. In other words, a short term gain may be followed by some sort of medium-term pain; investor beware.

Invest wisely, my friends.