Here’s how bank stocks might perform if the Bank of Canada starts hiking rates

Canadian bank stocks did not perform well during previous Bank of Canada rate-hiking cycles, but some analysts say the impact of a potential hike before year-end may be different this time because Canada is looking to accelerate the growth of key sectors, such as energy and defence, and attract $1-trillion worth of investments.

The United States Federal Reserve increased its benchmark interest rate by a quarter of a percentage point to a range of 3.75 per cent to four per cent last week to try to curb inflation that has been rising amidst the war on Iran and the resulting disruption of energy supplies.

The Bank of Canada held its key interest rate for the seventh consecutive time in early September, but it said the risks of higher and persistent inflation have increased because of the war. As such, the odds of a hike before year-end have increased.

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A rise in interest rates can benefit banks by boosting their profit margins in the short term, but it could also slow down their loan growth and lead to higher credit losses as consumers find it difficult to pay back the loans at a higher interest rate.

Bank stocks fell by 24 per cent on average during the past seven rate-hiking cycles since the early 1980s, before starting to go back up again, according to a Canadian Imperial Bank of Commerce analysis.

“The average drawdown (peak to trough) across those seven time periods was 24 per cent for the Canadian banks, with a range of minus 14 per cent (2004-2006) to minus 35 per cent (1986-1989),” Paul Holden, an analyst at CIBC, said in a note on Sept. 16.

“The average duration of the drawdown period is eight to nine months. The average drawdown for the TSX over those same time periods is 18 per cent and for the S&P 500 it’s 16 per cent.”

Gabriel Dechaine, an analyst at National Bank of Canada, said in a note on Sunday that the negatives of a rate hike could outweigh the positives, but the conventional risk factors the banks would face need to be considered within the current context.