The Bank of Canada did as expected last week, keeping its key overnight rate at 0.25% and further pledging to hold the rate at least until the middle of next year.

On the heels of the announcement, TD Canada Trust, the Royal Bank of Canada, CIBC and the National Bank of Canada lowered residential mortgage rates on some of their products, raising concerns at the C.D. Howe Institute a rapid rise in interest rates expected late next year could prove devastating for homeowners who have not evaluated their ability to carry their mortgage at a higher interest rate.

“The concern is ... does the simple experience of short-term interest rates being so low, for so long, encourage people ... to mortgage themselves more than they otherwise would, and buy a bigger house than they otherwise would ... and get themselves into trouble longer term?” said William Robson, C.D. Howe president and CEO.

The Institute’s 12-member monetary policy council’s median target for the overnight rate is for 1% in the second half of 2010. The council said the central bank should give a strong signal that an eventual overnight rate move may be quick and large. They also suggested the bank rein in the housing market by raising the required down payment on government-insured mortgages.

Canada’s slow economic recovery has been driven by a boom in the housing market, with sales of existing homes never stronger than in the recently completed third quarter.

Dawn Desjardins, assistant chief economist at RBC Economics, said still-volatile markets and global market uncertainties suggest a change to the central bank’s interest rate policy is premature.

But she added if the economy continues to build momentum by next summer, the bank will likely increase the rate by one percentage point.

Diana Petramala, an economist at TD Bank, said as long as economic fragilities remain, the Bank of Canada will not move quickly with interest rate hikes. She said the central bank’s projection for 3% growth in 2010 is slightly more optimistic than TD’s forecast of 2.7% growth, adding she believes the Bank of Canada’s first rate hike will not come until the fourth quarter next year.