September 8, 2004

Bank of Canada finally hikes rates
But housing market remains exceptionally strong

By Peter Diekmeyer o

After weeks of speculation, the Bank of Canada finally reversed its easy money course this morning, by raising its key overnight rate 1/4 of a percentage point, to 2 1/4%, the first time that it has done so since April 2003.

The much-anticipated rise, --which could be the first in a series of moves -- comes on the heels of positive statements by Bank officials regarding the health of the Canadian economy.

"(Recent) data indicate that Canada's economic growth in the first half of the year was somewhat stronger than the Bank had been expecting, largely as a result of more robust external demand for Canadian goods and services," read a statement announcing the move.

The Bank also hinted that more action might be on the way.

"With the economy operating at full capacity, monetary stimulus needs to be reduced to avoid a build up of inflationary pressures," said the Bank.

The interest rate hike ends a period of looser money that began with the Bank's July 2003 1/4 percentage point cut, which brought the overnight rate to 3.0%. Rates then fell a further 100 basis points, before bouncing back today.

Effect on consumers

The Bank of Canada's interest rate hike will have a direct on consumers, because many financial institutions' loan rates are linked to the overnight rate. For example the CIBC, Laurentian Bank and RBC Royal Bank all followed suit after the Bank of Canada's move, by raising their prime lending rates to 4.0% from 3.75%.

Mortgage rates tend to more closely track the bond market and do not typically directly track the central bank's actions. For example the Bank of Montreal kept its posted key five-year closed rate unchanged today at 6.34%. To find out how mortgage rate fluctuations affect the average Canadian family, click here:

Canadian housing market remains strong

The bank's rate hike comes amidst continued signs of strength in Canada's housing market.

According to a report issued by the Canada Mortgage Housing Corporation, housing continued to be one of the fasting growing sectors of the Canadian economy.

The report details the broad improvements that have been made in housing affordability since the mid-1990s, much of which was due to low mortgage rates.

Among the reports key highlights:

o Canadian home ownership rates are on the upswing, rising from 63.6% in 1996 to 65.8% in 2001
o House sizes are increasing, and the average number of people in each household has fallen from 3.9 persons in 1961 to 2.6 persons in 2001.
o Existing home sales set a record in 2003, with 439,000 dwelling sold through the Canadian Real Estate Association's multiple listing service.
o New housing starts hit 218,400 in 2003, a 15 year high.
o Housing growth was partly spurred by competition amongst lenders for mortgage business, which has lead to an increasing flexibility and a more diverse range of product offerings.

The strength in the housing market is likely to continue. According to a Statistics Canada report released yesterday, there were $4.8 billion worth of building permits issued during July, the second highest monthly total on record, just behind July's $5.4 billion.

The report listed the census metropolitan areas of Vancouver and Montreal as showing the largest increase in demand for new dwellings, with Toronto showing the largest year-to-date decline, when compared with 2003 data.

More hikes coming?

The big questions for most consumers remains how rates will move in the near future and the most likely scenario is up. According to one expert, the Bank's move today was just the beginning of what could be a series of hikes.

"As of an hour ago the bond markets were pricing in another 40 basis point rise by the end of the year," said Stéphane Marion, a senior economist and National Bank Financial. "In all likelihood, the Bank will proceed with a 25 basis point hike at each of its remaining two meetings this year."

But nothing is written in stone. In it's rate announcement statement, the Bank continued to hedge bets, listing the size of the "output gap," future Canadian trade growth and movements in oil and other commodities prices, as trends that it will be watching, prior to making its next move.



Previous Bank of Canada action:

Date Action Overnight rate (after announcement)

September 8, 2004 +1/4% 2. 1/4%
July 20, 2004 No change 2%
June 8, 2004 No change 2%
April 13, 2004 -1/4% 2%
March 2nd, 2004 -1/4% 2 1/4%
January 20th, 2004 -1/4% 2 1/2%
December 2nd, 2003 No change 2 3/4%
October 15th, 2003 No change 2 3/4%
September 3, 2003 - 1/4% 2 3/4%
July 15, 2003 - 1/4% 3%


Upcoming Bank of Canada rate announcements:

October 19th, 2004
December 7th, 2004


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