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Construction crew works on new homes under construction in Brampton, Ont., on July 13.CARLOS OSORIO/Reuters

The Bank of Canada’s interest rate increase is expected to deepen the chill in the country’s housing market and reinforce the view that property values will decline.

Home resales and prices have been tumbling since the central bank embarked on a series of rate increases as it seeks to arrest inflation. On Wednesday, the Bank of Canada announced an increase of a full percentage point – more than the consensus estimate of 75 basis points – pushing its benchmark interest rate to 2.5 per cent from 1.5 per cent. It is the fourth consecutive interest rate increase since March, and the first time the bank has raised its rate by a full point since 1998.

The central bank said that unsustainably high housing prices have contributed to excess demand in the country’s economy and warned interest rates would have to rise further to cool demand and lower inflation.

“Our goal is to get that demand down and part of restoring the balance of supply and demand in the Canadian economy is restoring that balance in the housing market and that’s what we’re aiming to do,” Bank of Canada senior deputy governor Carolyn Rogers told reporters at a news conference, adding that the bank expects “changes in housing activity and prices will feed through to overall economic activity.”

The higher rates will continue to increase borrowing costs, making it harder for prospective homebuyers to qualify for a mortgage and reducing the size of their loan. Borrowing costs have already doubled over the past year, after plummeting to record lows during the COVID-19 pandemic. By late afternoon on Wednesday, most major lenders said their prime lending rate would increase by one full percentage point to 4.7 per cent on Thursday.

Robert Hogue, assistant chief economist with Royal Bank of Canada, said the central bank action “will intensify the market cooling” in the coming months. “The hike will make it tougher for some buyers to qualify for a mortgage and reduce others’ mortgage size they can qualify for. The more bearish tone of the Bank of Canada’s statement is also likely to further dampen market sentiment.”

Robert Kavcic, senior economist with Bank of Montreal, said the large interest rate increase “will cast an even deeper chill on the market through the fall, and reinforce the change in market psychology.” He said: “Expectations of price declines are on the rise. This week’s rate hike will reinforce that shift.”

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Home prices have already dropped by double-digit percentages in some parts of the country, including the Toronto suburbs, which was one of the frothiest markets during the first two years of the pandemic. Home resales are well below prepandemic levels in places such as Vancouver, and the average home price across the country is trending lower.

Private-sector economists are forecasting home price declines of up to 20 per cent from peak prices in the first quarter of this year through early next year. A correction of that magnitude, however, would not bring prices back down to prepandemic levels. The typical home price across the country is at least 40 per cent higher than two years ago.

Nevertheless, the supersized interest rate increase caught the real estate industry off guard. “This was a total shock and completely unexpected,” said Samantha Brookes, the chief executive of brokerage firm Mortgages of Canada. “It’s going to have a huge effect on people.” Ms. Brookes said some of her clients had said before this latest increase they were unable to afford higher mortgage payments.

All mortgage holders will eventually have to pay more for their loans. For those with a fixed-rate mortgage, in which the interest rate remains constant for the term of the contract, they will pay more when they renew.

For the buyers who took out a variable-rate mortgage, which is based on a bank’s prime lending rate, they will see an immediate change to their payments. For those with fixed monthly payments, more of their payment will go toward interest and less toward principal, and the term of their entire mortgage will be extended. For those with variable-rate mortgages that adjust when the prime rate changes, they will have a higher monthly payment.

Ms. Rogers said the bank was cognizant of the fact that some homebuyers, especially those who bought during the frenzy, might have “stretched to do so.”

“There’s no doubt they’re being squeezed,” said Ms. Rogers. Though she added that those variable-rate mortgage holders represent a small segment of the population.

Would-be buyers are now qualifying for smaller loans, cutting them out of the priciest markets, such as Southern Ontario, and reducing competition for real estate. At the same time, federal rules have made it harder for borrowers to qualify for a loan from banks – which typically offer the cheapest mortgages.

Federal rules require borrowers to prove they can make their mortgage payments at an interest rate at least two percentage points above their actual mortgage rate. With interest rates on five-year fixed rate mortgages near 5 per cent, that means borrowers have to prove they can make their mortgage payments with an interest rate near 7 per cent.

“More and more of everybody’s daily personal income is going to be taken up by shelter costs by the mortgage cost,” said Don Scott, the chief executive of Frank Mortgage, a mortgage brokerage. “It’s going to put stress on their ability to continue to pay the mortgage, but also put stress on their ability to continue to pay for other things.”

Canada’s housing agency, Canada Mortgage and Housing Corp., recently cut its home price forecast, saying interest rates were rising faster than anticipated. The new forecast is for a mild price correction and the agency’s chief economist said he had a hard time believing home prices would plunge, given the imbalance between housing supply and demand.

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