Days Of Cheap Mortgages Are Numbered: Interest Rates Set To Rise

The days of rock-bottom interest rates may soon come to an abrupt end after February’s inflation numbers showed an unexpected increase, forcing the central bank’s hand much earlier than predicted.

Core inflation was estimated to hold steady at about 1.6%, but February showed a sharp jump to 2.1%, a benchmark that was not expected to be reached until the year’s third quarter.

The Bank of Canada has maintained interest rates at a record-low 0.25% for more than a year now and had committed to keeping them low, barring any complications with inflation. These complications, it would seem, have arrived – and sooner than expected.

“Economic activity in Canada has surprised slightly on the upside in recent weeks relative to the projection in our January Monetary Policy Report,” said the bank’s Governor, Mark Carney, in a speech in Ottawa this week. “Core inflation has been slightly firmer than projected, the result of both transitory factors and the higher level of economic activity.”

These ‘transitory’ factors have included the Winter Olympics recently concluded in Vancouver, B.C., which temporarily drove up prices in the western city, inflating revenues. However some analysts believe that even without the Olympics, Canada’s inflation would remain well above earlier projections.

While Mr Carny had pledged to maintain interest rates stable at least halfway through 2010, the pledge was ‘expressly conditional on the outlook for inflation’, and higher than anticipated inflation may soon force the bank to start raising rates. This would make Canada the first of the G7 nations to raise interest rates in the wake of the global financial crisis.

Just how soon the rate hikes will come, however, is hotly disputed. The next announcement is set for the end of April, and the more cautious believe that rates should be hiked as soon as possibly, to avoid the need for more dramatic hikes later. Others believe the bank will hold off until at least June or July.

Rising interest rates will undoubtedly have a dampening effect on the housing market, which has been spurred to tremendous growth by cheap lending rates and limited inventory. A slowdown in real estate transactions is likely to be welcomed in all corners, as continued growth is seen as unsustainable, leading to an inevitable ‘bubble’.

Variable-rate mortgage holders will be the first to be affected by rising rates, though some experts say that locking in to fixed rates may yet be premature, recommending instead that homeowners sit with a mortgage broker and run the numbers. There is also concern that rising rates will hit hardest at renewal time, especially for those that were on the margins of affordability at the current rate.

Most believe the interest rate hikes will be incremental, going up just one basis point (a quarter of a percent) per announcement, of which there are eight each year. This could see the year end benchmark rate at 2.25%.

Speculation on rising rates has also further strengthened an already strong loonie, with the Canadian dollar edging ever closer to parity with the US dollar.