Taking away the punch bowl
By Peter Diekmeyer • Bankrate.com

Central bankers worry that if an economy picks up too fast, inflation -- and asset bubbles -- could begin to form. And while the inflation numbers continue to look well contained, many observers have noted that Canada's housing market is beginning to look slightly overvalued relative to personal incomes and rents. Furthermore, according to Desnoyers, capacity utilization, particularly in the service sector -- which represents 75 per cent of the Canadian economy -- is not in nearly as bad a position as experts believe. That means companies could start boosting their prices sooner than expected.  

Because the Bank of Canada's traditional response to inflation threats has been to raise its policy rate, its role has been likened to taking away the punch bowl just as the party is getting started. A central bank rate hike has a significant influence on short-term market interests, notably short-term mortgage rates. That's important because interest payments represent by far the single largest expense for many homeowners.

What will happen?
Not everyone agrees with Desnoyers that interest rates will come back up that soon. "Our forecasts are pretty much in line with the Bank of Canada's reasoning and timetable. We expect that rates will increase in the second half of the year," says Adrienne Warren, an analyst at Scotiabank Group. "As a result, it would probably be better to buy a new house sooner rather that later."

Warren is not alone in thinking the rate hike won't come soon. "We still project that 2010's growth rate will fall short of those recorded during the early stages of previous recoveries, which will result in the bank holding off until the summer," wrote Dawn Desjardins, assistant chief economist at RBC Economics, in a recent note to clients. Desjardins believes the central bank will ultimately increase its policy rate by a full one percentage point during the second half of the year.

That may not sound like much, but if the move affects mortgage rates by a similar amount, it would boost monthly payments on a 30-year, $200,000 mortgage by $125, which works out to $1,500 over the course of one year. And if you extend that mortgage rate increase over the life of the mortgage, those who buy their first homes later in the year could pay up to $45,000 more in interest payments.

That buys a lot of punch bowls.

Peter Diekmeyer is a freelance writer living in Montreal.