Canada urged to hike rates in order to cool housing market

OECD says rate increases should happen this fall

Canada’s economy is gradually recovering and is expected to grow by 2.25 % this year and 2.5 % in 2013, according to a new report by the Organization for Economic Co-operation and Development.


Private consumption and investment will continue to be the primary drivers of growth in Canada, said the report, which was published Tuesday.


Canada’s growth will slightly outpace the OECD average, which is expected to be 1.6% in 2012 and 2.2% in 2013.

“It’s not a great outcome. A generation ago, coming out of a recession like this, we would have thought this was deplorable, but it’s not bad,” said Peter Jarrett, senior economist with the organization.


Assuming the euro zone “muddles through” its crisis, avoiding a Greek exit, Mr. Jarrett said OECD wants the Bank of Canada to start raising interest rates in the fall to avoid speedy inflation that will follow the economic growth.


“In order to head off that eventuality, we assume that beginning in the fourth quarter the Bank would move at a rate of a quarter of a point per quarter, bringing us to a rate of about 2.25 % by end of 2013,” Mr. Jarrett said.


The benchmark interest rate in Canada has been 1% since September 2010.


A rate hike is also needed to slow down quick-climbing housing prices. “We also feel that would help cool off the housing market in the places where it’s been hot and we expect it to remain hot in some of those places, particular in Toronto,” Mr. Jarrett said.


But if interest rates are increased, mortgages rates are also likely to rise, which could hinder the ability of some homeowners to make their payments. “We don’t want to end up in the same situation as our neighbours to the south,” said Mr. Jarrett.


The OECD report flagged Canada’s housing sector as imbalanced, but noted stiffer lending rules surrounding mortgages have helped reduce risk. The report comes on the heels of a Fitch Rating report released Monday that called Canada’s fast-climbing housing prices and record household debt levels unsustainable.


“The Bank of Canada is doing its best to ensure that lending is taking place on a prudent basis so that if indeed interest rates do have to go up more suddenly than one might have expected, then the number of people who can’t afford their houses is not too great and the impact on banks and lending institutions isn’t too great,” Mr. Jarrett said.


If Greece does leave its peers — the probability of which is rising, according to Mr. Jarrett — Canada will feel the effect through the financial markets rather than through its exports or bank-based contagion. Mr. Jarrett said a Greek exit would trigger a rush for low-risk assets, causing commodity prices to fall, and demand for the U.S. dollar, pushing down the loonie.


He said Canadian banks are better positioned than some their international counterparts to withstand a deeper crisis because they don’t rely as much on whole-sale borrowing. “The Canadian deposit base is quite solid compared to a lot of other countries,” Mr. Jarrett said.


Overall the global economy is slowly recovering, the OECD said, but at substantially different rates.


The euro zone crisis is dragging down the overall economic recovery.


“The crisis in the euro zone remains the single biggest downside risk facing the global outlook,” said OECD chief economist Pier Carlo Padoan in a statement.


Heading into a European Union summit in Brussels this week, the OECD urged leaders to take immediate action to avoid a deepening of the crisis in the euro zone and spillover effects to other nations.


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