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August was a sizzling month for home sales in many Canadian cities. Bank of Montreal economists now figure overall existing home sales rose by 13 per cent in August, after a 9.4 per cent increase in July. The MLS house price index probably rose by 3 per cent year over year, says BMO chief economist Doug Porter. Expect Finance Minister Jim Flaherty to be watching closely. If this kind of increase continues, Ottawa will likely make another policy move to cool sales in what some still consider to be one of the world's most overheated housing markets. But that probably won't be necessary.
Two factors are likely behind the hot summer sales activity. In July 2012, the federal government tightened mortgage rules for the fourth time in four years, leading to a sharp drop in transactions starting that month and continuing into this year. However, TD chief economist Craig Alexander, drawing on past data, predicted in January that demand would adjust over two to three quarters following the federal action until the market acclimatized to the new realities, before returning to normal. With the economy little changed from a year ago, that is now happening. Given the depressed sales levels starting in summer 2012, the year over year increase is even more pronounced.
However, there is another factor at play: rising interest rates. Given the increase in mortgage rates since May in tandem with rising benchmark bond yields in the U.S. and Canada, many prospective buyers likely hastened their purchases before they got caught paying higher rates. Mr. Alexander figures a one percentage point increase in interest rates would boost short term sales by six per cent – followed by a seven per cent decrease over the following few quarters, leading to a flat to declining market overall.
So sales might be surging now, but things should cool off by year's end, assuming economic conditions stay put. But what if sales continue to increase? Mr. Flaherty would no doubt act again to cool the market. But how?
After tinkering with mortgage rules several times, including shortening amortization terms, the government still has a few levers to pull. For example, it could force buyers needing mortgage insurance to show they could meet interest payments at higher levels than the posted rates. The federal banking regulator also appears to be looking at tightening mortgage rules.
But the option that gives economists concern is forcing buyers to increase the minimum downpayment from the current 5 per cent.
Anything more than an incremental boost would make first-time buyers cough up far more of their savings upfront. What savings, after years of ultra-low interest rates, you ask? Exactly . If the downpayment rate rose too much (say, by much more than a percentage point or two), too quickly, it would send buyers fleeing and prompt a significant correction in housing prices.
But the most effective tool for cooling the housing market may simply be rising interest rates. If employment continues to strengthen in the U.S., benchmark rates in North America would increase, followed closely by mortgage rates. That would no doubt cool the market, cutting into sales and shaving a few percentage points off prices. If the market's invisible hand does that, Mr. Flaherty won't have to do any strong-arming of his own.
Sean Silcoff is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here for more of his Insights, and follow Sean on Twitter at @seansilcoff.
Sean Silcoff