Should the BoC hike rates amid soaring home prices?

The bank has kept rates low again, but house prices are set to continue with double-digit gains

Should the BoC hike rates amid soaring home prices?
Steve Randall

The Bank of Canada opted to keep interest rates on hold again Wednesday despite the above-target rise in inflation and a sharp rise in house prices.

Governor Tiff Macklem said that inflation should start to ease by the end of 2021 as the temporary jumps in the Consumer Price Index (e.g. 3.6% in May) were due to the drop in prices a year ago due to the pandemic.

However, the low cost of borrowing – and a larger savings pot for many households – is fuelling demand in the housing market with prices rising sharply.

Real estate brokerage Royal LePage said Wednesday that the aggregate price of a home in Canada rose 25.3% year-over-year in the second quarter; and the firm is expecting a rise in demand in the fall as foreign students return and many Canadians who moved in with their parents during lockdowns look for their own homes again.

The firm’s outlook for the fourth quarter is a 16% year-over-year increase in the aggregate home price to $771,500. While a hefty increase, it does reflect a slower pace than at the start of 2021.

"After a year of record growth in the Canadian housing market, we appear to have passed the peak of price appreciation," said Phil Soper, president and CEO of Royal LePage. "While current home price gains are expected to be sustained due to chronically low inventory and new demand from growing household formation, investors and newcomers, the torrid pace of home price appreciation has begun to moderate."

He added that those who have saved a larger down payment but still been frozen out of the market, should be able to buy a home as price acceleration eases.

Hike rates?

With the double-digit rise in home prices here at least until the end of the year, should the Bank of Canada act to curb borrowing by beginning interest rate hikes?

That’s a question posed to a panel of economists by financial comparison site, three quarters of which said they think the BoC will hold rates until at least the second half of 2022.

Despite surging home prices, most of the panel believe that holding rates is the right decision, given the slack in the wider economy that needs to be tightened before rates rise.

“Raising interest rates is a blunt tool to address the hot housing market, and would likely have unintended negative consequences for the broader economy,” noted Tony Stillo, director of Canada Economics at Oxford Economics, a sentiment shared by many of the experts.

However, Atif Kubursi, president Econometric Research Limited, sees it a different way, and was the only panellist who believed the BoC should have increased rates this week.

“Cooling the real estate market and other asset markets is now a prudent policy objective. The BOC has kept an inflation target solely fixed on the goods market. This has exacerbated income and wealth inequality and frustrated the capacity of young people to own their own homes. There will be negative political, social and economic consequences to this blindness to what is happening to asset bubbles.”

Supply side

Whatever the trajectory of interest rates, real estate professionals have long called for supply of new homes to be increased to address the issue of housing affordability.

"All too often our political leaders fall into the 'quick fix' trap, throwing new taxes or regulations at the housing economy which do little but temporarily push people to the sidelines, creating pent-up demand,” said Royal LePage’s Soper. “That temptation looms large now. Yet, what Canadians do not need are pandemic-era policies in a post-pandemic economy. We need to address the fundamental flaws in our development approval processes, so we may someday have the homes our people require. It is our only hope to address housing affordability."