BoC overreach poses threat to housing market

By Maddie Johnson | May 9, 2022 | Last updated on May 9, 2022
2 min read
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© Hirohito Takada / 123RF Stock Photo

Rising interest rates are already having a positive cooling effect on Canada’s red-hot real estate market, but overly aggressive tightening could spark a correction, CIBC’s deputy chief economist says.

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“Clearly, this is a market that is highly sensitive to higher interest rates,” CIBC’s Benjamin Tal said, after housing prices increased dramatically during the Covid-19 pandemic.

“The key risk that this market is facing is an overshooting by the Bank of Canada,” he added.

The Bank of Canada raised its benchmark interest rate last month to 1% from 0.5% and made it clear that more hikes are coming.

Already, brokers across the country have said properties are seeing fewer offers than just a couple of months ago.

“We have a situation in which the stress test is becoming a major issue, preventing people from getting the house that they want, and they are slowing down in their purchases,” Tal said.

He forecast rates reaching 2.5% by early 2023, which could result in a “significant shock” for the housing market.

If the central bank stops at around 2.5%, Tal predicts the market will adjust “but will not correct in a very significant way.”

However, if the Bank of Canada continues to 3.5% — as Tal said the market is now pricing in — it could mean the difference between an adjustment and a correction, increasing the probability of a recession next year.

“If the Bank of Canada continues to go aggressively to fight inflation, and inflation is a major issue, then the likelihood of a more significant correction is going to go higher and higher,” he said. 

Higher borrowing costs will lead some speculators to exit the market, which is already happening in the condo space, Tal said.

That said, he is bullish on the rental market after the value of homes relative to rent went up dramatically over the last couple of years.

“Now we are seeing some catching up happening,” he said. “I see increased demand for rental units and not enough supply.”

As for government measures on housing affordability, Tal said their effect is likely to be limited for now.

The federal government is trying to improve supply but it will be some time before the market sees the benefit. At the same time, the Liberals are encouraging first-time home buyers to enter the market with the new First Home Savings Account (FHSA).

However, Tal said the impact of rising interest rates is more significant than measures to help buyers.

“I don’t think that [the FHSA] will reverse the slowing in the market in any significant way,” he said. 

More likely, the market will adjust to higher borrowing costs topping at 2.5%, Tal said, without a correction. He pegged the probability of the Bank of Canada overshooting — spurring a recession and a housing market correction — at about 30%.

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Maddie Johnson

Maddie is a freelance writer and editor who has been reporting for since 2019.