Bank of Canada unclear how higher interest rates may impact Canada’s housing market

The Bank of Canada’s leadership appears to be torn over whether Canada’s housing market will brush off or be further impacted by the higher interest rates, according to the central bank’s first ever summary of its internal policy deliberations.

Until now, the Bank of Canada’s senior leadership debated whether or not to change the country’s monetary policy behind closed doors. The release of the Bank of Canada’s deliberations for its January 25 decision to hike interest rates by another quarter percentage point gives a window into how the central bank thinks about the health of the housing market.

“With respect to the housing market, there was concern that the effects of tighter monetary policy could be larger than expected,” read the Bank of Canada’s summary of its governing council deliberations. “This could arise if the decline in housing prices were to accelerate.”

In spite of last year’s price erosion, the average Canadian home today is priced higher than it was before the COVID-19 pandemic began. This dynamic is largely expected to continue, according to the Canadian Real Estate Association (CREA). It expected the national average home price to decline nearly 6% in 2023.

That said, CREA’s latest housing market forecast in January doesn’t seem to suggest a quickening decline in housing prices. Over the course of 2023, CREA says the price of an average Canadian home is expected to recover by about 3.5%, to $685,056 – or back on par with 2021 levels.

“National home sales have been more or less stable since the summer,” CREA’s January report says, “suggesting the downward adjustment to sales activity from rising interest rates and high uncertainty may be in the rear-view mirror.”

CREA doesn’t call the 2023 situation a recovery, “but the start of a turnaround,” thanks to the overall adjustment of Canadians to higher interest rates, as well as the relative uncertainty of future housing growth. Last December marked one of the lowest new supply levels ever.

However, the Bank of Canada seems to think continued strong immigration rates to Canada, along with “household formation,” would support the housing market’s continued growth. Over the next three years, the Canadian government plans to attract nearly 1.5 million permanent residents – and they all have to live somewhere.

Christopher Alexander, the president of RE/MAX, told the Financial Post he expects home buyers won’t stay renting forever thanks to rising rents.

“Despite higher mortgage rates, the monthly payments versus renting are more attractive so I think we’re gonna see a shift from renting to buying somewhere towards the end of the spring this year,” he told the newspaper.

There is also the possibility that buyers who’ve remained on the sidelines due to rate hikes decide to jump into the housing market in the hope the Bank of Canada takes a pause, or even cuts rates.

Bank of Canada governor Tiff Macklem made it clear on Feb. 7, the day before the deliberation summary was released, that the bank would only be pausing rate hikes to see whether its monetary policy was working.

“We will be assessing economic developments relative to the forecast,” Macklem said in his speech, referring to the bank’s assessment of the Canadian economy in January. “If new evidence begins to accumulate that inflation is not declining in line with our forecast, we are prepared to raise our policy rate further.”

In its January policy deliberations, the Bank of Canada decided to hike interest rates by a quarter percentage point due to continued strong job, wage and gross domestic product growth over the third quarter of 2022. All of these factors can contribute to inflation.

“In other words, data on both the labour market and economic activity suggested that there was more excess demand in the economy in the fourth quarter of 2022 than previously forecast,” the Bank of Canada’s deliberation summary read.

Overall inflation did drop to 6.3% year-over-year in December, according to the bank, from a high of 8.1% in the summer of 2022. But much of that drop is due to falling gasoline prices. Food and shelter costs remain high, but the bank felt Canada is turning a corner on inflation.

“While Governing Council was acutely aware of ongoing uncertainty,” the Bank of Canada’s deliberation summary read, “they concluded that data since the October (monetary policy report) had largely reinforced their confidence that inflation would come down through 2023.” 

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