We think most of the tightening will occur after the jobless rate has peaked (in the first half of 2010) and before total and core inflation get back to the 2% target (in mid-2011).
The first hike cannot occur before the third quarter of 2010 in our view.
An aggressive tightening – rather than a gradual one – will be necessary because rates are extremely low.
A “measured pace” would not be appropriate to “normalize” rates when the starting point is virtually zero.
“For argument’s sake, if we assume the Bank hikes by 25 basis points for each of the 12 fixed interest rates decisions in a year and a half starting in July 2010, the overnight rate would be only 3.25% at the end of 2011.”
“3.25% could well prove to be too low for an economy that would be running at a decent pace with inflation already at the 2% target. This means we are likely to see a mix of 50, 75 and even 100 basis points hikes…when the time comes!”
In sum, Laurentian Bank suggests rates could jump 3%+ in the next few years, starting in 9-12 months.
Do others agree? Well, if they do, not many are putting it on the record.
Real estate bear, Garth Turner, is one exception. He saysBoC chief, Mark Carney, “knows he’s playing a high-stakes game of rate roulette, aware ultra-low rates can do as much damage as good.” Turner believes Carney will be “adamant” about controlling real estate and inflation with higher rates.
If rates do start ramping up next year, it could have two meaningful implications:
Canada’s real estate market would no longer have interest rates as a support mechanism.(This recent Royal LePage survey reinforces how critical low rates have been for sustaining home demand: Link)
Highly-leveraged homebuyers (with little savings or equity) could be in for some hurt.Let’s consider, for example, a homebuyer taking out a $250,000 mortgage (including default insurance).
He or she jumps into a 3.35% three-year fixed rate with a 35-year amortization. All is dandy.
Then, rates rise 3% in the next 36 months and payments jump 39%…from $1,008 to $1,401.
If he or she has a high total debt ratio (for example: 42-43%), a $400 payment increase would inflate the borrower’s debt ratios like a balloon. That could:
A) Strain or break the monthly budget; and/or,
B) Force him/her to renew with the existing lender at “rack rates” (i.e., whatever average-Joe renewal rates the lender is offering at the time.)
The borrower would probably be unable to switch to another lender with a better deal because a 39% higher mortgage payment would push the total debt ratio over the 40-44% limit. For similar reasons, he/she wouldn’t be able to refinance or move and port their mortgage. This would be the case even if income rose the typical 2.3% a year (the average annual income increase over the last 10 years).
There are naturally exceptions to the above, but you get the idea.
Long story short, rates can and do go up. Once we start seeing more robust GDP and inflation reports, you’ll see more economists increasing their rate projections. While some people are advising to buy now because rates are low, not everyone should take that advice.