Bank of Canada – could it pause rate hikes as market slows?

All eyes will be on the Bank of Canada once again next week with the central bank widely expected to announce its largest rate hike of the year in the next policy rate announcement, scheduled for July 13.

Anticipation of a three-quarter-percentage-point (0.75%) increase to the Bank’s benchmark rate has grown in recent weeks after the United States Federal Reserve announced a similar measure in mid-June to combat surging inflation.

In Canada, inflation has ballooned to its highest level for nearly 40 years, coming in at 7.7% in May – higher than many observers had predicted and all but confirming that an oversized rate hike by the central bank is in the offing.

A 75-basis-point increase would mark a fourth consecutive hike by the Bank, which has raised that trendsetting rate by 1.25% since the beginning of the year after it sat for nearly two years at a rock-bottom 0.25%.

The impact of those changes – which affect both would-be and existing variable-rate mortgage holders – has been keenly felt in the mortgage and housing markets. Both have witnessed a pronounced slowdown in recent months following a pandemic-era boom.

The average selling price of a home across the country has plummeted by 13% since February, according to the Canadian Real Estate Association (CREA), with the volume of sold homes registering a 20% drop in May over the same time last year.

After setting a scorching pace during the first two years of the pandemic, monthly activity has now returned to the pre-pandemic levels of the second half of 2019, CREA said, and sits slightly above the 10-year average.

The Bank doesn’t seem in any mood to change course on its rising-rate trajectory, with Governor Tiff Macklem indicating it “may need to take more interest rate steps” to get inflation under control in the coming months.

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But could a significant or accelerated downturn in Canada’s housing market give the central bank pause for thought on its plans to hike rates even further?

That’s unlikely, according to David Macdonald (pictured top), senior economist at the Canadian Centre for Policy Alternatives, who told Canadian Mortgage Professional that the possibility of a further housing market cooldown paled in comparison with the Bank’s primary goal of curbing inflation.

“The housing market will be the first casualty of inflation-targeting interest rate increases,” he said. “The Bank of Canada is not terrifically concerned about house prices.

“They have one role, when push comes to shove: to get inflation to 2% come hell or high water. The real estate market is going to be a bump on that road. I think a bigger bump is going to be a recession – that’s probably one of the only ways to get there. But I don’t think the real estate market concerns the bank particularly.”

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Home prices will most likely continue to decline in direct proportion to increases in the Bank of Canada’s overnight rate, Macdonald said – and the possible knock-on effect on investor sentiment could be profound.

Canada saw eyewatering home price appreciation during the pandemic – CREA said its non-seasonally adjusted benchmark House Price Index soared by over 29% between February 2021 and the same month this year – with investors playing a key role in that growth.

In a June report, the Bank of Canada said the share of Canadians buying homes as investment properties had risen in 2021, with the share of investors in the mortgage market totalling around 22% in 2021’s fourth quarter (up by 3% compared with 2019).

“One of the drivers has been investors who have been using cheap money to speculate in housing markets,” Macdonald said. “I’m not convinced that a lot of them want to be landlords for the next 30 years. I think a lot are probably in the market to get rapid capital gains and get right back out again.”

Steep depreciation in property values could see investors “rush for the doors” – potentially leading to an accelerated sell-off, higher inventories and more downward pressure on house prices than could be caused by the Bank of Canada’s rate increases, Macdonald said.

“There are likely thresholds or points where investors rush for the exits,” he said, “and you could see much higher declines in house prices as a result.”