Mark Carney Suggests Rate Hikes Looming

Bank of Canada Governor Mark Carney said again that the bank may have to raise interest rates to keep inflation on target.  This would mean in increase to variable rate mortgages.  He said it was not necessary to be more explicit about timing of a possible move but said that Canada was “well into an expansion”.  The timing and degree of any increase “will be weighed carefully against domestic and global economic developments.”

The bank’s most recent estimate of the output gap (the difference between potential GDP and actual GDP) is about a half percent, indicating that the Canadian economy is growing above trend and will do so over the balance of the year.  Compared to the major advanced economies, the Canadian economy is performing well by any measure.  It also predicted a return to full capacity for the first time since the recession by the first half of 2013 — as much as six months earlier than anticipated.  Growth in the Canadian economy, it expected, will be 2.4 per cent through the end of 2013.

The governor said he was well aware of the global risks and added “there are also risks domestically, and they are two sided”

The report comes a day after the central bank announce it was keeping its benchmark bank interest rate unchanged at one per cent, but hinted strongly that it is uncomfortable with super-low rates that encourage Canadians to borrow and mortgage more than they should.  In a special section within the report, the bank estimated that Canadians are borrowing on rising home values to an unsustainable degree.

Home equity lines of credit and mortgage refinancing has grown from about $8 billion in 2001 to $64 billion in 2010, with about half of that “equity extraction” going into consumption or to pay off other debt.

“Home equity extracted through additional borrowing cannot fund higher consumption indefinitely,” the bank warns. “With less equity in their homes, households would also be more exposed to decline in house prices, which could further dampen consumption.”

“Growth in residential investment, which is currently supported by very favourable mortgage financing conditions, is forecast to slow,” it states, but the ratio of household spending to GDP will likely remain high. “In that context, the ratio of household debt to income is projected to rise further,” the bank concluded.

BMO economist Michael Gregory predicted that the bank will start raising rates around the end of this year or early next, if it believes its prediction for reaching full capacity is on course.  This will mean an increase to variable rate mortgage holders.

The TD Bank’s Francis Fong suggested a hike of no more than one percentage point over the next year and a half, especially with the U.S. Federal Reserve likely on hold until 2014.

“Disproportionate Canadian rate hikes would lead to enormous pressure on the loonie — something the Bank of Canada has little appetite for given the already uneven recovery in the export sector,” said Fong

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