For a second time this year, the Bank of Canada (the Bank) has raised interest rates. As of September 6, 2017, the overnight lending rate is 1 per cent, up from 0.75 per cent.
Two increases in a single quarter certainly bucks the trend that the Bank had been setting since 2010. Before July 12, 2017, there hadn't been any movement in interest rates for 7 years. That being said, the interest rate increase is not surprising given the current strength of the Canadian economy. In its press release, the Bank presented an optimistic view: growth in Canada is becoming more broadly-based and self-sustaining.
Increases in interest rates are typically associated with dampened investment activity. In particular, the cost of an acquisition financed by a loan increases when rates are hiked. Saving becomes attractive in a high interest environment.
However this is not a hard and fast rule, particularly in the M&A context. Gradual interest rate increases which occur in times of healthy economic growth can be a sign of corporate confidence. Higher confidence levels could actually encourage dealmakers to engage in transactions.
Plus there are other factors that may affect the pace of dealmaking more significantly than modest changes to interest rates. Currency values, equity valuations and geopolitics all play chief roles in M&A discussions in 2017.
Notably, interest rate increases affect private equity acquirers more than strategic buyers (i.e., buyers who are looking to acquire to take advantage of synergies and operational efficiencies). For the latter type of buyer, the interest rate news is unlikely to be a determinant in an acquisition decision. As well, acquirers using a high ratio of capital over debt to finance acquisitions are impacted less by interest rate increases.
As the last interest rate increase occurred quite recently, the jury is still out about the actual effects of the the Bank's July increase. However observers have predicted that increasing interest rates are unlikely to stifle M&A activity in Canada. In any case, it will be fascinating to see how the September increase (and the signals the second increase gives about the Canadian economy) will play into M&A activity numbers for 2017.
The Bank's next announcement regarding interest rates is scheduled for October 25, 2017. The October announcement will be accompanied by a full update regarding the Bank's outlook for the economy and inflation.
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