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TORONTO, July 12 - Canada's first interest rate hike in nearly seven years will likely be jarring for consumers accustomed to rock bottom rates, and heavily-leveraged households fed by years of cheap credit should start paying down debt, analysts said, given more rate hikes are anticipated.
Household debt in Canada is the highest among Group of Seven countries.
The Bank of Canada has warned that record debt combined with rapidly rising home prices pose a risk to the financial system. After its 25 basis point rate increase on Wednesday, the central bank acknowledged that the economy may be more sensitive to higher interest rates than in the past given the country's amount of household debt.
"We will need to gauge carefully the effects of higher interest rates on the economy," the bank wrote.
The Bank of Canada raised its official interest rate to 0.75 percent from 0.5 percent, the first increase since 2010. The five major commercial banks, led by Royal Bank of Canada , raised their prime lending rate to 2.95 percent from 2.7 percent, effective Thursday.
Higher interest rates are beneficial for banks because their net interest margins, the difference between the interest they get from borrowers and what they pay to savers, improves, resulting in increased profitability.
Analysts say the initial 0.25 percent hike may not have a material impact on earnings but further anticipated increases could boost profitability, particularly in 2018, potentially helping offset slowing housing markets in Toronto and Vancouver.
For a Canadian family with a C$500,000 ($393,000) home mortgage, the rate increase is likely add about $100 per month, said Laurie Campbell, chief executive of Credit Canada Debt Solutions, a non-profit group that advises consumers in debt.
Campbell said this would not initially be a problem for consumers, but, she said, low savings and a lack of retirement planning could lead to more bankruptcies if rates rise again this year as expected.
Canadian households owed $1.67 in debt for every dollar in disposable income in June. Since 2009 when the housing boom started, total household debt has risen 51.5 percent to C$2 trillion and mortgages account for about 66 percent of that, according to Statistics Canada.
"People are living too close to the edge," said Scott Hannah, president of the Credit Counseling Society. "If you are carrying non-mortgage debt, you need a plan to eliminate this debt."
Bank of Canada Governor Stephen Poloz told reporters, "I know not everybody will think a higher interest rate is good news, but it's a symptom of an improving economy.
"Interest rates are still very low, so we're coming off a very low level."
Brad Lamb, a Toronto-based property developer, said in a telephone interview that higher borrowing costs were unlikely to cool Canada's hot real estate market. "Demand for housing is growing. This is not going to stop the march going forward," Lamb said. ($1 = 1.2717 Canadian dollars) (Reporting by Chris Arsenault; Additional reporting by Matt Scuffham; Editing by Toni Reinhold)