Banks See A 2.75% Rate Hike In 19 Months

April 10, 2010

Economists at the Big 5 banks worked overtime this week, polishing their rate forecasts and fielding calls from reporters.

It seemed every major media outlet in the country ran stories on where interest rates are headed.

Here’s what the “prophets’” predict rates will do by the end of next year (2011):

• BMO: +3.00% (Report – a rounded average)
• CIBC: +2.25% (Report)
• Scotia: +2.75% (Report)
• TD: +3.00% (Report)
• RBC: +3.25% (Report)

That’s an average estimated increase of 2.75% in the overnight rate (rounded to the nearest 1/4%).

This number will certainly bring doubters out of the woodwork, as some still fear slow growth and/or a double-dip recession.

As for the first rate change, the banks forecast that rates will start their climb by July. Specifically:

• BMO: July 20
• CIBC: July 20
• Scotia: June 1
• TD: July 20
• RBC: July 20 (“Although, markets are becoming
  anxious about a June increase,” RBC says.)

We’ll get a better sense of the date when the BoC makes its next interest rate announcement in nine days.

The next question is: Once rates start rising, how fast will they run up? According to BMO, “The Bank (of Canada) probably has a predilection to raise policy rates expeditiously.”

The average economist polled by Bloomberg expects a one percentage point increase by the end of this year. In turn, that suggests a 175 bps hike in 2011…if the bank consensus is correct.

If prime rate jumps 2.75%, that could mean a 35% payment increase for certain floating-rate mortgage holders. (e.g., payments could jump $284 on a regular $200,000, 1.75% variable mortgage amortized over 25-years). This assumes the banks don’t “give back” the 1/4% they withheld when prime rate dropped 3/4 of a percentage point in December 2008.

As for fixed mortgage rates, the bond market will plot their destiny as usual. CIBC economist, Avery Shenfeld, suggests bond yields could run up more than some people expect—at least initially:

“Once the first hike is in place, the bond market is likely to become even more aggressive in its expectations for subsequent moves. The first hike could also prompt more Canadians to fix their variable rate mortgages, putting even more pressure on five-year yields. Still, hikes in 2011 won’t end up being as steep as what the bond market will, at some point, fear.”

The big banks see the 5-year bond yield hitting 3.75% to 4.10% one year from now. Based on historical spreads, that would put typical discounted 5-year fixed mortgage rates at roughly 5.13% in 12 months—an 88 basis point increase from today.

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Sidebar: As always, take any rate prediction with a dose of scepticism. Rate forecasters attempt to see through very muddy waters and the economy can change considerably between now and the end of this year.

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