Higher interest rates will result in a stronger dollar, which will be bad for business.
Back in July it was pretty big news when Bank of Canada Governor Stephen Poloz announced a 0.25 percent key interest rate increase, the first rise in rates in seven years. More recently, due to strong economic performance, we’ve seen another increase.
How will this news of higher interest rates, and perhaps more to come, affect Canada’s auto business in the middle of the best year ever for auto sales?
What most new vehicle buyers may assume is that the cost of higher interest rates will get passed onto them today. It is actually unlikely in the short term that that would be the case.
For the most part, manufacturer new vehicle incentive budgets will likely absorb the rate hike for consumers so that they can continue to advertise zero or 0.9 percent or 1.9 percent for new cars.
The manufacturers will likely adjust other programs to absorb higher borrowing costs, resulting in less cash incentive.
To keep it in perspective, on a $40,000 car loan a hike of 0.25 percent is only an extra $100 per year of interest.
All that said, if rates continue to climb, at some point the OEMs will have to pass along those costs to the consumer. This will then eventually raise monthly payment, all else being equal.
Strong Canadian dollar
The bigger impact of a rate increase is its immediate effect on the strength of the Canadian dollar, compared with the U.S. dollar, and what that will mean to the Canadian auto industry. Typically an interest rate hike means more valuable Canadian currency. That more valuable dollar is of greater concern, for both the new and used vehicle market in Canada.
The dollar increased $0.08 from early May to late July, which is a very significant climb, and we’ve seen it climb ever higher in more recent months.
This could lead to an eventual cooling of new vehicle sales and is expected to cause Canadian used vehicle prices to fall over time, from their record high levels. As the strength of our dollar had been declining since 2013, U.S. interest in Canadian used vehicles increased.
Depending on who you ask, upwards of 200,000 vehicles have been exported to the U.S. annually. U.S. buyers and/or Canadian exporters have been taking full advantage of a lower Canadian dollar and moving vehicles across the border to sell at a higher price in the States versus here at home.
This export demand has inflated our used car prices domestically.
As a result, Canadian consumers are being pulled out of their vehicle loans and leases early by dealers who are eager to sell the consumer’s current vehicle on the used market and put the consumer into a brand new one, often for the same or lower monthly payment. This “pull forward” activity is helping to drive record levels of new vehicle sales.
This phenomenon is likely due to higher used vehicle prices putting consumers into a positive equity position (owe less than the vehicle is worth) much sooner.
U.S. market pressures
Given that the domestic supply of U.S. used vehicles is up by about 500,000 more off lease units versus past years, U.S. used prices are falling. The Black Book (USA) Price Index is showing a ten percent decline since last year, which is significant.
The U.S. vehicle market is bracing for a large downward adjustment in used prices. Add in a stronger Canadian dollar driving up acquisition costs, and there will be less demand in the U.S. for Canadian used vehicles.
At some point soon, the rising Canadian dollar and falling U.S. used vehicle prices will make it unattractive for U.S. buyers to purchase Canadian inventory in such large volumes.
The impact to the Canadian auto industry will be a slowdown of “pull forward” activity, as it won’t make economic sense to pull as many consumers out of their vehicles early because their vehicles won’t command such high prices on the used market.
Canadian Black Book expects that a $0.85 dollar is around the tipping point for U.S. exports to significantly slow.
When I look at our own data for wholesale prices, in July they are quite flat compared to previous years, noting that a decline has yet to appear.
That lack of price increase in itself is noteworthy, as trucks and SUVs have been going up in value around four percent per year, over the past three years.
On the positive side, Canadian used vehicle shoppers and used vehicle dealers will be rewarded with better deals when buying in the market, compared to what they have seen over the last few years.
Unfortunately the days of shipping or selling to the U.S. might be numbered, of course… at least until the dollar reverses course and we start all over again!