How far should the Canadian home price correction go?

BMO Economics says policy is not yet going far enough

How far should the Canadian home price correction go?

On top of the approximately 13% decline in benchmark prices from levels seen in early 2022, a further 12% correction might be needed to ensure sufficient buyer activity to keep the housing market stable, according to BMO Economics.

A drastic price drop that will ensure significantly improved affordability appears to be the only way to soothe the Canadian economy’s troubles, BMO said in a new analysis.

“Discretionary spending on travel and in-person services is about to face the cold, hard reality of mounting bills due to high inflation and rising credit costs,” BMO said. “With mortgage payments resetting at rates some 3% to 4% higher than at origination, indebted households will need to cut spending by many thousands of dollars each year.”

However, even if consumers are likely saving up more due to these expectations, BMO said that this is not necessarily a prelude to a surge of housing activity.

“While housing market activity could bottom soon given some recent easing in fixed mortgage rates and a conditional pause on policy rates, a hearty recovery is unlikely given still-poor affordability,” BMO said. “Canada’s economy looks to contract modestly in the first half of the year while registering 0.5% growth for all of 2023.”

The Bank of Canada is not likely to follow the US Federal Reserve’s lead when it comes to further rate hikes this year, but Canadian households are still likely to remain severely indebted “and thus, sensitive to higher loan costs, and do not benefit from 30-year fixed-rate mortgage terms,” BMO warned.

“Moreover, when the US economy spins in reverse, Canada usually gets vertigo, meaning it won’t be immune to the US debt ceiling drama.”