Mortgage rates on the upswing

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Canadian banks are once again ratcheting up mortgage rates, as government bond yields rise because of worries about inflation and growing confidence in the global economic recovery.

Toronto-Dominion Bank and Canadian Imperial Bank of Commerce were the first two banks out of the gate with mortgage hikes Monday. Both banks raised the rate on their standard five-year fixed mortgages to 5.44 per cent, an increase of one-quarter of a percentage point, or 25 basis points. Economists predict the other major banks will soon follow suit, perhaps as early as Tuesday. The yield on five-year Canadian government bond yields has gone up sharply of late, jumping 24 basis points last week alone, and mortgage prices closely track these bonds.

The recent yield spike coincides with a skyrocketing equity market that is fuelled by soaring energy and resource prices. The higher these prices rise, the more likely it is that investors will move their money out of fixed-income securities and into stocks, which sends bond yields higher.

The mortgage hikes also come at a time of growing concern about Canadians' record debt levels, and just weeks after Finance Minister Jim Flaherty moved to tighten up the mortgage market by making a series of changes, including reducing the maximum term of a mortgage from 35 years to 30 years for borrowers who require mortgage insurance. Those reforms come into effect March 18, and are expected to cause softening in demand for mortgages from new home-buyers.

Government bond yields directly affect mortgage rates because the banks must pay more money to borrow in the bond market so that they can lend that money to consumers. "This is not a strategic move by any bank," said Benjamin Tal, the deputy chief economist at CIBC, who attributed the increase to the yield environment.

If a chorus of economists is to be believed, the upward pressure on rates won't subside any time soon. Craig Alexander, chief economist at TD, said that the rise in mortgage rates can be traced to growing expectations of inflation in the United States and strong indicators for U.S. economic growth.

Plus, by historical standards, borrowing costs are still relatively low. TD and CIBC's new five-year rates are still about 1 full percentage point lower than where they were last April, when the European debt crisis broke out. Mr. Tal expects five year-bond rates to jump by another 50 or 60 basis points over the next year, pulling mortgage rates up with them.

Mr. Alexander has a similar forecast. He sees bond yields rising by about 65 basis points before the end of the year and expects that the Bank of Canada will raise rates by 100 basis points, causing variable-rate mortgages to rise by one percentage point.

Peter Aceto, the chief executive officer of ING Direct Canada, said his bank has not yet decided whether to move its mortgage rate but added it is likely it will do so in the next few days. He, too, believes Canadians should expect industry-wide mortgage rates to rise steadily throughout the year, although the pace of change will depend on the degree of confidence in the market.

"I think a year ago we thought that rates were going to go up sooner, but the world was a little less stable than we thought," he said.

Mr. Tal agrees, and cautions that unexpected events will have an impact.

"The bond market, and therefore mortgage rates, dance to the tune of the nervousness of the market at this point," he said. "The minute you get some scary news from Europe, say Ireland, that can scare the market and all of a sudden you can see a blip. So this is going to be an upward trend with a lot of volatility."

Mr. Flaherty's move to shrink the length of mortgages essentially has the same effect as rising rates, by increasing monthly payments. For example, at a 4-per-cent interest rate, monthly payments on a $300,000 mortgage would increase by $104 if the term fell from 35 to 30 years, BMO Nesbitt Burns senior economist Michael Gregory pointed out in a note to clients. That's equivalent to an increase of 56 basis points in the mortgage rate.

The chartered banks held about $506-billion worth of mortgage loans in November, up from $468-billion in January, according to the most recent data from Statistics Canada.

Despite the federal government's changes and expected rising mortgage rates, Mr. Alexander does not expect a shock to the housing market. Rather, he sees the housing market going "sideways."

"This is not going to lead to a correction in the Canadian housing market, but we are going to see home sales come down about 10 per cent and home prices come down about 1 per cent," he predicts.