Tara PerkinsFrom Tuesday's Globe and Mail
Published on Monday, Mar. 29, 2010 9:16PM EDT

Canadian banks delivered the first clear sign that the era of rock-bottom interest rates is over by suddenly hiking mortgage rates, a move that will cost Canadians more to finance home purchases and likely hasten an expected slowdown of the red-hot housing sector.

Surging home sales and prices were already expected to cool in the second half of this year as more listings hit the market and the Harmonized Sales Tax adds to purchase costs in Ontario and British Columbia.

Hikes on fixed-rate mortgages announced by three banks Monday are expected to contribute to the slowdown as home buyers face higher costs amid a growing expectation that interest rates are likely entering a phase of higher levels.

The hikes are also expected to push some homeowners who have enjoyed ultra-low variable mortgage rates to lock in at set levels. Readings on inflation and the resurgent economy point to rate hikes within a few months by the Bank of Canada, whose trendsetting rate influences variable mortgage rates.

Royal Bank of Canada boosted the rate on five-year fixed-rate mortgages by 60 basis points to 5.85 per cent Monday, a move matched by Toronto-Dominion Bank. Rates on three- and four-year fixed-rate mortgages also rose by between 20 and 40 basis points (a basis point is one-hundredth of a percentage point). Laurentian Bank announced similar changes. Other major banks are likely to follow with rate hikes of their own.

The rate hikes carry the hallmark of a cyclical turn in mortgage prices as opposed to a blip, said Peter Routledge, senior vice-president of financial institutions at Moody's Investors Service.

“It's possible that we'll get a 10 or 15 basis point correction but the direction is up, not down,” concurred Canadian Imperial Bank of Commerce economist Benjamin Tal.

“This interest rate cycle has turned,” he said. “The next move will probably be another increase, although it won't be 60 basis points. It will be much more moderate.”

While many Canadians with variable-rate mortgages are keeping an eye out for signs that the central bank's rate hikes are near, Monday's moves are a reminder that mortgage rates can rise before then. (The central bank's key rate has a much bigger influence on short-term consumer lending rates than longer-term rates.)

Sarita Pereira, an office manager in Brampton, Ont., decided to call her banker Monday to decide if it was time to lock in to a fixed-rate mortgage. Until now, Ms. Pereira and her husband have been happy with the variable-rate mortgage they signed in 2007 for their $359,000 four-bedroom home. “Sometimes it's just good to ride the wave, especially if you can take on a little bit of risk,” she said. But now she's worried the wave may have crested.

Mr. Tal said there has been a rise in the number of people locking in their rates in recent weeks. “And I suggest you will see a wave, a significant move, into fixed rates,” he said.

“Given where interest rates are now, I still think you'll see an extremely strong spring. However, after that I think the housing market will stagnate,” Mr. Tal said. “We are in the ninth inning of this booming house market. We are not expecting a crash, but we will stagnate.”

Mr. Tal noted that, while interest rates are at historical lows, affordability, or consumers' ability to cope with their debt, is not. That's because low rates have prompted Canadians to take on bigger mortgages, he said.

“The rates are tied to our funding costs, which change day to day,” said Gillian McArdle, a spokeswoman for RBC, which has a Canadian mortgage portfolio of about $148.5-billion. “Our long-term funding cost has gone up significantly since December.”

The price of fixed-rate mortgages fluctuates along with bond yields.

Yields on five-year government of Canada bonds have risen about 25 basis points since the end of February. They are being driven by a growing heap of positive economic data and an awareness that inflation is creeping higher. There is a growing expectation that the central bank will boost its key rate by July, or sooner. Sal Guatieri, a senior economist at Bank of Montreal, said he still expects the Bank of Canada will raise rates in July, but he added that further strong economic reports could speed that up.

In addition, the U.S. bond yields have climbed amid weaker demand for government debt issues, and ongoing worries about the U.S. government's fiscal picture.

The Bank of Canada's decision to slash rates to all-time lows fuelled the housing market by spurring demand for variable-rate mortgages, a significant factor behind the economy's muscle. As that situation reverses, and as the stimulus spending dries up, it's possible that the economy will begin to disappoint the market later this year, Mr. Tal said.

Toronto-Dominion Bank chief executive Ed Clark told reporters last week that he thinks low rates have caused a lot of consumers to act earlier than they otherwise would have. “Our sense of the market would be that this has topped out here, and you're going to see a much slower second half” of the year, Mr. Clark said, pointing to the HST and rising central bank rates.