Will the Bank of Canada’s interest rate cut spur the housing market?

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Pent-up demand is likely to drive up both sales and prices

Published 09 June 2024Last updated 6 hours ago4 minutes reading time

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New homes in East Gwillimbury, Ontario, 2018.New homes in East Gwillimbury, Ontario, 2018. Photo by Cole Burston/Bloomberg Files

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When the Bank of Canada cut its overnight interest rate by 25 basis points last week, real estate experts reacted in large part to the 25 basis point cut in the benchmark interest rate. On the one hand, some believe that a cut will support the weakening real estate market, on the other hand, others believe that the cut is not large enough to influence market developments this summer.

Real estate markets are extremely sensitive to interest rate fluctuations, which in turn affect mortgage rates and monthly mortgage payments. Historically, property sales have reacted strongly to changes in interest rate regimes, so it is of paramount importance for lenders and mortgage seekers to assess the likely impact of falling interest rates.

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Regional housing markets from coast to coast contribute to the national housing market. While regional deviations from the national average are important in local decisions, the overall impact of interest rate movements must be examined at the national level.

The latest data from the Canada Real Estate Association (CREA) suggests that sales in April 2024 were significantly lower than peak sales in early 2021. COVID-19 is primarily responsible for the wide fluctuations in post-pandemic sales and prices.

What impact does a long-term perspective have on markets? Interestingly, April sales are largely in line with the longer-term pre-pandemic trend of 40,000 seasonally adjusted monthly sales. Equally important is the realization that home sales have mostly been below the long-term average of 40,000 sales since June 2022. If average pre-pandemic trends had continued, one can estimate a deficit of about 70,000 sales since June 2022.

Given the favorable environment, new home buyers – who were previously inactive – as well as people who had been hesitant to buy in anticipation of cheaper interest rates, are likely to return to the market this summer in search of bargains. This pent-up demand should drive both sales and, to some extent, prices higher than seen in the recent past.

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Homebuyers are greeted with a wealth of choices. New listings have been increasing since the third quarter of 2023, and the sales-to-new listing ratio has been below 60 percent nationwide for nearly a year. The downward trend in recent months suggests that sellers are anticipating increasing demand and have entered the market earlier than buyers.

The claim that interest rate cuts drive up housing prices is widely accepted in the economic literature, although there is also research that challenges this assumption. Analyzing the impact on housing prices from both the short-term and long-term perspectives can lead to different conclusions. In the short term, it is clear that average housing prices in Canada are currently below the peak reached in early 2022.

The long-term view, which comes from extrapolating the trend of average price growth in Canada from 2005 to just before the pandemic, suggests that current housing prices are significantly higher than their long-term average trend. The expected price increase, albeit modest, due to the interest rate cuts will keep prices significantly higher than their expected long-term trends, which could put downward pressure on sales growth this summer.

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Previous research in real estate markets suggests that the impact of interest rate cuts is moderated by expectations of future price increases. In a 1989 article in the Journal of Real Estate Finance and Economics, Jack C. Harris explained that homebuyers are motivated by expectations of future prices, which rise when interest rates are low or expected to fall. Expectations of future prices remain “influential even during periods of declining and moderate real prices, not just when prices are rising,” Harris noted.

Recent research by Gregory D. Sutton and others for the Bank for International Settlements confirmed that, unlike sales, house prices are more sluggish. They concluded that “changes in interest rates and other factors affect house prices gradually rather than immediately. This suggests that modest cuts in policy rates are unlikely to boost house prices quickly.”

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The Bank of Canada will review its decision on mortgage rates regularly in July, September, October and December as it will be closely monitoring inflation. Interestingly, any increase in housing prices caused by lower borrowing costs is likely to affect inflation and give the central bank cause to think further.

If buyers expect property prices to rise, the summer property market will likely see higher sales volumes. Therefore, even moderate interest rate cuts will impact sales volumes, if not prices, in the short term.

Want to know more about the mortgage market? Read Robert McLister's new weekly column in the Financial Post to find out the latest trends and details on finance opportunities you can't miss.

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