Interest Rate Increases

Higher interest rates on way, Carney warns
March 25, 2010


OTTAWA–Bank of Canada Governor Mark Carney has put Canadians on notice that today's rock-bottom borrowing costs are likely headed upwards by midsummer – if not sooner.

He acknowledged Wednesday that inflation and economic growth are rebounding faster than the bank predicted and left the door open for a rise in the central bank's trend-setting overnight rate more quickly than Canadians have expected.

Nearly a year ago, Carney decided to combat the recession by taking the unusual step of promising to keep the bank's overnight rate at a record low 0.25 per cent until the end of this June.

But, in a reminder that he has the option to hike rates sooner, he drove home the point on Wednesday that he has always said the bank would re-examine its stance if inflation – its main concern – threatened to get out of control.

The commitment to rock-bottom interest rates "is expressly conditional on the outlook for inflation," he reiterated in a speech to the Ottawa Economics Association.

"The bank has an unwavering commitment to price stability," Carney said.

"That means keeping inflation low, stable and predictable," he added.

Rising Bank of Canada rates cause commercial banks to follow suit, driving up borrowing costs for consumers, homebuyers and business. This slows economic expansion and cools inflation, but it is not without risks. Raising rates too quickly could slow Canada's rebound from the recession.

Economic growth and price increases have both exceeded expectations in recent months. The core inflation rate, which excludes volatile items such as gasoline, rose to 2.1 per cent in February, Statistics Canada said last week.

This is considerably more than had been predicted by Carney, who forecast that core inflation would average 1.6 per cent in the January-through-March period and not hit 2 per cent until the second half of this year. The bank's long-term goal is to head off runaway inflation, which it tries to do by manipulating interest-rate policy to keep price increases in the 2 per cent range.

With inflation rising, analysts have speculated that the bank might not wait until mid-year to raise interest rates.

But Carney was careful not to tip his hand, saying Canadians will have to wait until the bank's next interest-rate setting on April 20 for a decision. As for a reading of inflation dangers, the bank will publish its analysis in its quarterly report on April 22.

In the meantime, he warned Canadians that sooner or later interest rates will be rising now that the economy is recovering from the recession.

"We're not trying to give personal financial advice," he said at a news conference. But "certainly in any sort of major purchase or financing that individuals are considering, (they should) recognize that interest rates are at extraordinarily low levels" and will be going up, Carney said. Canadians should "think about your ability to service your debts if rates move to a more normal level."

While acknowledging inflation is "slightly firmer" than the bank forecast and economic expansion in the early months of this year is stronger than expected, Carney was guarded in his assessment of the outlook.

He pointed out that Canadians are dealing with "an economy that is just emerging from a very deep recession."

And he noted that the sharp rise in inflation in February may reflect a one-time phenomenon – the rise in accommodation costs during the Vancouver Winter Olympics.

Still, the fact Carney is not hinting at any changes to his year-old promise to hold the bank's overnight rate at 0.25 per cent until the end of June is an indication borrowing costs will likely be going up at mid-year, said CIBC World Markets economist Avery Shenfeld.

"By saying nothing about what happens after June, it starts to become a hint that rates will move up in July."

But it will be a tricky call for Carney because pushing up rates could strangle the economic rebound and drive up the value of the loonie on exchange markets, hurting the ability of exporters to sell goods in the key United States market.

"We're still in the relatively early stages of a recovery, and I think the bank probably should err on the side of trying to stimulate the economy," said United Steelworkers economist Erin Weir.

"The other big risk of raising interest rates too soon is that it could drive the Canadian dollar even higher, which of course would hurt export industries and could staunch the recovery."


JONATHAN'S OPINION

One issue of vital importance to all those that currently possess variable rates on their mortgage is, should you fix them?

In listening to a forecaster from BMO today, he mentioned that at this time next year, the prime rate will be 2% higher than it is today. This means that it will be at 4.25%. This will, in turn, force the fixed rates on, say a five year term, to reach at least 7%.

Today you can get a five year fixed mortgage rate at approximately 3.8%. In my opinion, rates are the lowest they've ever been, and they must go up in order to halt inflation.

If I were you, I would lock in today. If not, at least keep a keen eye on them.