by Tom Bradley

In recent weeks, we’ve seen interest rates increase. The Government of Canada (GOC) 10-year bond has gone from yielding 1.4% on June 2nd to 1.9% today.

There are strong views on both sides of the interest rate debate. For those who believe rates should stay low, a key argument relates to inflation. Because the Consumer Price Index (CPI) is not going up (it’s bouncing around 1.5%), rates shouldn’t go up either.

I’m on the other side of the debate (rates are too low) for a number of reasons, but perversely enough, I’m also using inflation to make my case that interest rates need to increase.

When it comes to inflation, I think commentators and economists are confusing trends and momentum with absolute levels. Let me explain.

If I’m buying a bond or GIC, I want to be assured that I’ll get my money back when it matures along with a return that compensates me for the risk and offsets inflation over the period. The last part is key. I want my money to have more buying power at maturity than when I invested it. Maybe only a little bit, but I don’t want to be worse off.

With interest rates having increased, we’re getting back into positive territory. The yield on the GOC 10-year is now slightly above the current level of the CPI.

I don’t know where interest rates will eventually settle, but I do believe the recent increase is fully justified. Inflation is low, but rates were even lower.