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Rate-hike burden is seen as bearable

Ellen Roseman
Toronto Star
July 11, 2007

Few foresee sustained tightening campaign, partly since the strong Canadian dollar is doing the work

The Bank of Canada, as expected, raised its key rate by a quarter- point yesterday - the first time in more than a year.

But that increase, likely to be followed by another quarter-point increase this fall, probably won't have a major impact on most Canadians.

The rising loonie is helping to restrain economic growth and bring down inflation. That should help the central bank bring down inflation to its target level.

"I think this is close to the end. After another increase in September, the Bank of Canada will have to be convinced to go further," said Douglas Porter, deputy chief economist for BMO Capital Markets.

"While the Bank is likely to hike again in September, they seem to be sending a fairly clear message that they don't foresee a sustained tightening campaign, partly because the strong Canadian dollar is doing some of the work for them."

Benjamin Tal, an economist with CIBC World Markets, agrees that rate increases won't be major.

"The maximum this year is 50 basis points," he says. "The Bank of Canada hinted not to get too excited."

Craig Alexander, deputy chief economist at TD Canada Trust, feels sympathy for manufacturers hit with a profound exchange rate shock and decreasing demand from the United States, a major trading partner.

But a rising currency helps dampen inflation, thus making interest rates less volatile for consumers.

"With the Canadian dollar up significantly and economic growth moderate at 2. 5 per cent, it doesn't suggest we're at the start of a major cycle of interest rate hikes," Alexander says.

"Inflation has proven to be a little stickier than the bank anticipated. The target is 2 per cent and we've exceeded that for the past 10 months.

But there are no signs that inflation is accelerating. So, the central bank is just tweaking rates."

An interest rate increase helps savers and hurts borrowers. It's a mixed blessing.

If you're a saver, you should see higher rates for term deposits, guaranteed investment certificates and money market funds. Bonds will do well, too, if you hold them to maturity and don't trade them (since bond prices go down when rates go up).

"There's a liquidity bubble, with a lot of money sitting on the sidelines looking for direction," Tal says. "The inflow into GICs is highly correlated with interest rates. Interest will have a little bit of power as an alternative to the stock market."

When it comes to interest-paying investments, the best rates you can get are from online banks. ING Direct pays 3.5 per cent on savings with no minimum balance, but has a temporary 4.25 per cent rate for new deposits made until Aug. 31.

HSBC Bank Canada is offering 5 per cent on accounts opened through its online banking service until Oct. 10.

When it comes to the Canadian economy as a whole, savers earn more in interest than borrowers pay in interest.

"So, it's not a bad thing for the economy that savers will have more interest options, " Tal adds. "However, the savings are concentrated among those over 55 years old. They're not the people who are paying the mortgages."

The mortgage market started moving up after the Bank of Canada signalled rising rates in late May. That led to higher Canadian bond yields, which in turn led to higher rates for fixed-rate mortgages.

Variable-rate mortgages should be affected by yesterday's announcement, but they account for only 21 per cent of the total mortgage market.

Fixed-rate mortgages account for 73 per cent of the total, up from 67 per cent a year earlier, according to the Canadian Association of Accredited Mortgage Professionals.

Combination mortgages, in which part of the loan is based on fixed rates and part at variable rates, account for the remaining 6 per cent.

Housing economist Will Dunning has found a shift toward fixed-rate mortgages among those who had recently renewed their mortgages. And when asked about renewals, almost half said they would opt for long-term mortgages.

If mortgage rates increase by half a percentage point, the average increase in monthly interest costs will be about $35 a month, Dunning says.

"To make up a $35 a month shortfall, the adjustments you have to make are not that huge."

Neil Glasberg, president of Invis, Canada's largest mortgage brokerage firm, came up with a similar figure for the average increase.

A year ago, a competitive discounted rate for a five-year, fixed-rate mortgage available through a mortgage broker was 5.5 per cent.

After several recent increases, the current rate for a new five-year, fixed- rate mortgage for creditworthy borrowers is 5.79 per cent.

On a $200,000 mortgage with a standard 25-year amortization, these rate increases mean an extra $33.97 on the monthly payment (which now stands at $1, 254.75).

New mortgage options help ease the squeeze on borrowers.

For example, if you want to keep your cash flow the same when mortgage rates increase, you can opt for a longer amortization period than the standard 25 years.

Posted on Wednesday, July 11, 2007 at 03:58PM by Registered CommenterElaine | Comments1 Comment | References1 Reference

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Reader Comments (1)

The payments may be "bearable" but the total interest over the term can hurt. On an average Canadian home (now about $300,000), a 1/4 point hike costs you over $3600 in additional interest if you're fully mortgaged. Ouch!

Have a wonderful day,
July 18, 2007 | Unregistered CommenterOnline Mortgage Broker

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