THE COST OF CREDIT IS DOWN, BUT PEOPLE FEAR TO BORROW
THE COST OF CREDIT IS DOWN, BUT PEOPLE FEAR TO BORROW
Like a lot of other salesmen along “automobile row,” a string of car dealerships on the outskirts of Saint John, N.B., Jack Brown is wondering what it takes to lure hordes of eager customers back into his showroom. Brown is the new car sales manager at Dobson Chrysler Dodge, which last week offered buyers loans at an interest rate of 5.9 per cent. Before the economy plunged into a recession three years ago, Brown says a rate that low would have triggered a rush of buyers into his dealership. But while new car sales at Dobson so far this year are up by about 10 per cent over the same period last year, Brown says that they are still far below their robust pre-recession levels. Like other sellers and manufacturers of so-called big ticket items—cars, houses, furniture and appliances—Brown says that even the lowest interest rates in more than 25 years have so far failed to convince
recession-battered consumers to begin borrowing and spending again. “The low rates alone aren’t enough to do what they could be doing,” he says. “Even if rates were at zero per cent, a lot of people still wouldn’t be buying because they don’t know if they’ll have a job next week.”
That widespread uncertainty has dampened the potential impact of the country’s lower interest rates. In the past, economists say, lower rates have been the most effective way of encouraging consumers to buy new houses, cars or other large items. Such renewed borrowing and spending, in turn, has been a powerful force in lifting the economy out of slumps—boosting production and employment in those consumer-oriented industries as well as the demand for raw materials and related goods and services. But even though most interest rates are now at about half their prerecession levels, many Canadians are
J. COCHRANE/FIRST LIGHT
still in no mood to buy. Economists say that reluctance is understandable: unemployment remains stubbornly high at 11.3 per cent of the labor force, wages and salaries are stagnant and many families are still loaded down with high debts from the 1980s. As well, governments are slashing jobs and raising taxes. As a result, says Earl Sweet, assistant chief economist for the Royal Bank of Canada: “The effect of the interest rate reductions hasn’t been as large as one would have thought.”
Last week, rates continued to drift down. The Bank of Canada lowered its trendsetting annual rate to 4.58 per cent from 4.73 per cent. A day earlier, the Big Six chartered banks dropped their benchmark prime lending rates, the interest charged on loans to their most credit-worthy corporate
borrowers, to 5.75 per cent from six per cent. Most banks and trust companies also lowered their charges on home-purchase loans, slashing their one-year mortgage rate, as one example, to 6.5 per cent from 7.25 per cent. In fact, apart from a sharp upward spike in interest rates in the weeks following the constitutional referendum on Oct. 26, 1992, interest rates have declined steadily over the past three years.
Still, in some sectors, those declines have had a positive impact on spending. Last week, the Canadian Real Estate Association reported that sales of existing homes in Canada’s 25 largest cities climbed by 4.3 per cent in June to 19,425, the second monthly increase in a row. “With mortgage rates coming down, we hope to see resales continue their upward trend,” said the association’s president, David Higgins. But in the crucial market for new homes, builders are still struggling to attract buyers. Nationwide, housing starts, expressed on an annualized basis, declined to a rate of 119,680 a year in May, down 17 per cent from the same month in 1992—and well below the average of more than 200,000 starts a year before the recession.
Like many builders across Canada, Peter Bell-Nejneldeen, the president of the Saskatchewan division of Edmonton-based Reid-Built Homes, the largest homebuilder in the province, says lower rates by themselves have had little impact on buyers. “We thought when we got down near the six-per-cent mortgage rates that
they had in the United States, that it would be great,” Bell-Nejneldeen says. But even at those rates, he adds, “People are still keeping their money in the bank.” Bell-Nejneldeen says he understands why potential buyers are reluctant to take the plunge. Even though Statistics Canada declared the recession officially over in January of this year, he claims, “Everybody is still worried about their jobs.” As well, like many homebuilders, Bell-Nejneldeen argues that Bank of Canada governor John Crow has lowered rates too gradually. Declared Bell-Nejneldeen: “The way they held those rates up for so long—that really killed a lot of people.”
Auto dealers also doubt whether lower interest rates will be able to kick-start sales the way that they have in the past. Total sales of new cars and trucks dipped to 117,232 in June, down seven per cent from May and below the level for June in each of the past three years. In addition to fears about job security and high debt loads, dealers say that consumers have been confused—and spoiled—by several years of low-interest financing and rebate schemes. As a result, Brown says, many buyers view single-digit interest rates as a sales gimmick. Said Brown: “If you’re talking about the average guy off the street, he’ll say, ‘Just take it off the sticker price of the car instead.’ ” Furniture and appliance sellers say that they, too, have yet to feel much of a boost from the latest round of interest rate reductions. At Sears Canada Inc., Canada’s largest department store chain and dependent on big-ticket items for half of its
sales, total revenues declined to $772 million in the first quarter of 1993 compared with $775 million a year earlier. “We’ve always believed that lower interest rates would result in higher sales,” says Sears vice-president of public affairs Ross Rigney. But, he added, “People are not buying new furniture for the new house or redoing the one they have.”
Still, Rigney says consumers are opening their wallets a little—but only for small cash purchases. “Apparel, cosmetics—even drapes—are good,” he says. “But as for carpets, furniture and appliances, it’s strictly replacement.” Nationwide, the trend is the same: overall consumer spending is up, but sales of big-ticket items are flat. The Royal Bank’s Sweet and other economists say that this differs markedly from past recoveries, when there was little if any lag between interest rate drops and higher sales of big-ticket items.
Other experts, however, question whether Canadian interest rates are all that low, after taking the inflation rate into account. Nominal interest rates are at their lowest levels since the middle 1960s. But the annual inflation rate has also declined to 1.6 per cent and is now holding steady at the lowest levels since the late 1960s. Michael McCracken, president of Informetrica Ltd., an Ottawa-based economic consulting firm, points out that so-called real interest rates—the difference, or spread, between nominal interest rates and the inflation rate—are high by historical standards: the real prime rate charged by banks, for example, is 4.15 per cent compared with 3.45 per cent two years ago. They are also high when compared with interest rates in the United States. “Most of our interest rates are 1.5 percentage points higher than they are in the Unifed States—but our inflation rate is half of what theirs is,” McCracken says.
As well, Ottawa and the provinces have chosen not to augment any potential economic stimulus from interest rate declines with tax cuts or spending increases. Manufacturers and sellers of big-ticket items say that governments’ deficitcutting is undermining the impact of lower interest rates. “How will you react as a consumer if you know you’re going to pay higher taxes,” asks Rigney. He adds that the prospect of widespread public sector layoffs is also hurting sales of housing and big-ticket items, particularly in Ontario and Quebec. Declared Rigney: ‘Those 950,000 civil servants in Ontario have always been good customers. Traditionally, they never worried about their jobs or their incomes.”
But experts are sharply—and typically—divided on what, if anything, governments can do. McCracken argues that Crow has room to lower interest rates even further, and that governments should lower taxes or increase spending—or both. He argues that tax revenues would eventually soar as consumers started borrowing and spending again and the recovery gained momentum. But other economists, including those who hold sway with the Conservative government, argue that spending increases and tax cuts, coupled with sharp interest rate cuts, would fuel inflation. That, they say, would drive rates up again and bring the recovery to a halt.
For the moment, both Ottawa and the provinces appear to be committed to restraint. As a result, the Royal Bank last week revised downwards its forecast for economic growth in 1993 to 2.9 per cent from 3.4 per cent. Sweet blamed “muchlarger-than-expected tax increases” for eroding consumer confidence and choking off demand. It also means that car dealers, homebuilders and other sellers of big-ticket items will have to rely even more on their persuasive skills to win over new customers.
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