Economists say BOC could raise interest rates by one per cent in mid-2010

Date: Wednesday, December 9th, 2009

Sunny Freeman, The Canadian Press

TORONTO — The Bank of Canada repeated its pledge Tuesday to keep interest rates at historic lows until the middle of next year to stimulate growth and a sense of stability in the midst of an unsteady economic recovery.

But many economists are predicting rate hikes as much as a full percentage point or more later next year, and say the bank’s commitment to keep its key overnight rate at 0.25 per cent creates a false sense of security among borrowers who have taken on debts larger than they could normally afford.

The median target for the overnight rate of the C.D. Howe Institute’s 12-member monetary policy council is for one per cent in the second half of 2010.

The council said the central bank should give a strong signal that an eventual overnight rate move may be quick and large. They also suggested the bank rein in the housing market by raising the required down payment on government-insured mortgages.

C.D. Howe president and CEO William Robson said a rapid rise in interest rates expected late next year could prove devastating for homeowners who have not evaluated their ability to carry their mortgage at a higher interest rate.

“The concern is…does the simple experience of short-term interest rates being so low, for so long, encourage people…to mortgage themselves more than they otherwise would, and buy a bigger house than they otherwise would … and get themselves into trouble longer term?”

Meanwhile, the central bank also announced Tuesday that the global economy has been slightly more positive than it was at the time of the bank’s October pronouncement, but that “significant fragilities remain.”

The Canadian economy grew less than analysts expected in the third quarter of the year and inflation has been slightly higher than the central bank expected. Its target is two per cent.

Dawn Desjardins, assistant chief economist at RBC Economics, said still-volatile markets and global market uncertainties suggest a significant change to the central bank’s interest rate policy is premature.

But she added that if the economy continues to build momentum by next summer, the bank will likely increase the rate by one percentage point.

Diana Petramala, an economist at TD Bank, said as long as economic fragilities remain, the Bank of Canada will not be swayed to move quickly with interest rate hikes.

She said the central bank’s projection for three per cent growth in 2010 is slightly more optimistic than TD’s forecast of 2.7 per cent growth. She believes the Bank of Canada’s first rate hike will not come until the fourth quarter of next year.

Canada’s slow economic recovery has been driven by a boom in the housing market, with sales of existing homes never stronger than in the recently completed third quarter.

Cameron Muir, chief economist at the B.C. Real Estate Association, said low interest rates have played a key role in home sales, which have rebounded dramatically compared with the beginning of the year.

“When we look at that target overnight rate staying fairly static for the next six months, that bodes well for homebuyers,” he said.

But he forecasted long-term and short-term mortgage rates will edge up in late 2010.

“In the next 12 to 18 months, it’s likely that rate is going to start heading higher and it’s going to have an impact on those consumers who have short-term variable rates and home equity lines of credit,” Muir said.

The C.D. Howe’s Robson said there is risk of a housing bubble stemming from interest rates set too low. “People are getting a little bit too used to this emergency low on the overnight rate,” he said.

If the economy grows at four or five per cent, the overnight rate cannot stay down at one or two per cent, he said. Over a longer period he sees interest rates jumping, with a high of five per cent and an average hovering around three per cent.

Meanwhile, the Bank of Canada announcement repeated, but softened, its warning on the persistent strength of the Canadian dollar acting as a “significant drag” on growth.

An October pronouncement on interest rates warned the soaring loonie was undermining Canada’s economic recovery to such an extent that it was more than offsetting the more favourable developments seen over the summer.

But Robson said he believes the risk is debatable and said the Canadian dollar is strong for fundamental reasons.

“It’s a symptom of a buoyant outlook for Canada, it’s not an independent cause of weakness in the future.”

He said the Bank of Canada’s preoccupation with the high exchange rate also encourages people to think the overnight rate is going to stay low longer.

“The Bank of Canada’s OK with that because they see that as important to stimulate the economy. But if you look at the housing market you have to wonder, are we seeing too much of a good thing?” he said.

Lawrence Kobescak

Lawrence Kobescak

Lawrence Kobescak, the creator behind OntarioMortgageSuperstore.com is a real estate sales representative, mortgage agent and real estate investor. OntarioMortgageSuperstore.com has reached over 240,000 Canadians since 2009. Lawrence has been quoted in the Globe & Mail and MortgageBrokerNews.ca.

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