Canada risks housing-related recession from aggressive rate hikes

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The Bank of Canada’s increasingly hawkish tone on inflation could potentially stall home sales, says Capital Economics

Publication date:

07.06.2022 • 4 days ago • 3 minutes read • 95 comments A for sale sign outside a home in Calgary. A for sale sign outside a home in Calgary. Photo by Azin Ghaffari/Postmedia

According to a report by a Capital Economics economist, Canada could be at risk of a recession triggered by a rapidly correcting housing market if the Bank of Canada becomes too aggressive in raising interest rates.

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In an update on Tuesday, senior Canadian economist Stephen Brown noted that the central bank appeared unfazed by a double-digit decline in home sales in May – the second straight monthly decline – and that it was adopting an increasingly dovish tone on inflation.

“This increases the likelihood that the bank will decide on a larger rate hike at its July meeting and makes us concerned that it will take a more aggressive approach to tightening monetary policy than is ultimately required, which is driving house prices sharply lower and a risk of severe recession. ” he said.

National home sales fell 12 percent mom in May after falling 14 percent in April. While Brown suggested the declines would bring sales closer to pre-pandemic norms, the balancing of supply and demand gave him more cause for concern.

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In addition, company data revealed that the falling sales-to-new-listings ratio in key markets including Toronto, Montreal, Vancouver and Calgary implied home price inflation could fall from 18 percent in April to zero by the end of the year.

Home prices are already falling, slipping 0.6 percent month-on-month across the country, according to Capital Economics data. In Toronto, prices fell even faster by more than 3 percent in May for the second month in a row.

Brown noted that Canada’s housing sector took up little space in the bank’s policy statement that accompanied its decision to raise interest rates by 50 basis points on June 1, saying only that “housing market activity is slowing from exceptionally high levels.” “.

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The bank will present its 2022 financial systems review on June 9, in which it may elaborate on the weakening real estate market.

With inflation at a multi-year high – Canada’s price index rose 6.8 percent in April – the bank has signaled it is ready to crack down on rising consumer prices with stronger rate hikes. Bank of Canada Governor Tiff Macklem suggested in April that the central bank could temporarily raise the federal funds rate above the neutral 2% to 3% range, which would neither help nor hamper economic growth.

Deputy Governor Paul Beaudry echoed this sentiment in a June 2 speech a day after the latest interest rate decision, saying the bank must raise its reference rate to at least 3 percent to tame inflation.

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However, Brown argued the danger is that the bank will miscalculate the impact of its aggressive tightening policy and potentially stall home sales.

“If the bank were to raise interest rates to 3.5 percent … the housing market would take the most dramatic hit to affordability since the Volcker shock in the early 1980s,” Brown said, referring to the time when the US chairman Federal Reserve, Paul Volcker, aggressively hiked interest rates.

Brown added that his company estimates that a policy rate of 3.5 percent would bring the average five-year mortgage rate to 4.5 percent and the average variable rate to 4.9 percent. Despite accelerating wage growth this year, Capital Economics estimates these mortgage rates would cut the maximum home price buyers could afford by 23 percent, which Brown estimates will have four times the impact of the previous three tightening cycles.

• Email: [email protected] | Twitter: StephHughes95

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