When we talk about higher interest rates, we usually do it in the context of fighting inflation – higher rates discourage investment and spending which slows the economy and, by extension, inflation.
But there is a second angle on higher interest rates that is often overlooked – that’s government borrowing.
As our federal government’s annual deficit and accumulated debt grow, foreign buyers have to be enticed to buy bonds or paper to fund that debt. The incentive is higher interest rates.
We’ve just received a report on those transactions and it appears to be working. We set a record for foreign investment in government paper in May and then topped that in June as the Bank of Canada raised rates twice through that period. Interestingly, investment in Canadian corporate stock went down.
Government borrowing has to be financed from somewhere and that usually means foreign investors who look at growing mountains of debt as an increased risk worthy of a premium return.
The bottom line here is that consumers being overly exuberant with inflationary spending is not the only factor pushing up interest rates.
