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Central bank raises its rate; competition will keep mortgage rates down
Jan 27, 2006

The Bank of Canada’s decision to again increase its interest rate by a quarter of a percentage point to 3.75 per cent is expected to moderate the real estate market this year, according to the Canadian Real Estate Association.

“Rising interest rates is the primary reason why housing activity in 2006 is expected to moderate compared to the record levels posted last year,” said CREA chief economist Gregory Klump.

It was the fourth increase of one-quarter of a percentage point since September 2005, when Canada’s central bank began to raise the overnight lending rate for the first time in almost a year. 

At that time, it said the economy was running near full capacity. 

Since then, the bank has said the economy is now running full tilt and faces capacity constraints. Further interest rate increases are anticipated in the coming months to head off inflation pressures. 

“The Canadian economy is expected to grow slightly faster than the estimated non-inflationary rate of 2.9 per cent this year,” said Klump. “Given the tightness of Canada’s product and labor markets, the Bank of Canada continues to signal its intention to keep hiking its trend-setting bank rate. 

“It is widely expected that the bank rate will rise a further one-half of a percentage point between now and spring,” Klump added.

“Since bonds respond to inflation expectations and mortgage rates track bond yields, we expect the five-year conventional mortgage to rise by no more than another one-half of a percentage point in 2006.”

At the end of 2005, the five-year conventional mortgage rate stood at 6.3 per cent.

Stiff competition among mortgage lenders, however, continues to help borrowers negotiate discounts off the advertised rate. 

“Higher mortgage rates are expected to gradually cool resale housing activity in 2006,” Klump added.

“Information received since the last interest rate announcement on December 6 indicated that the Canadian and global economies are evolving essentially in line with the bank’s expectations as set out in the October Monetary Policy Report,” said the Bank of Canada in a news release, announcing the recent increase. 

“The Canadian economy continues to adjust to global developments and to the associated changes in relative prices. Consumer Price Index inflation, at 2.3 per cent in the fourth quarter of 2005, was lower than expected primarily because of lower gasoline prices. As anticipated, core inflation remained stable at 1.6 per cent.”

The bank said CPI and core inflation should return to the two-per-cent target by the first half of 2007. 

“Risks to the bank’s projection remain balanced for 2006 and tilted to the downside through 2007 and beyond,” said the Bank of Canada. 

The bank said its current assessment of risks indicates that “some modest further increase in the policy interest rate would be required to keep aggregate supply and demand in balance and inflation on target over the medium term.”

The bank’s next scheduled date for announcing the overnight rate target is March 7.