Canada will need more Bank of Canada rate hikes to cool housing frenzy, economists say

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The Bank of Canada’s decision to raise interest rates on Wednesday is not expected to cool the country’s frenzied real estate market, with homebuyers still able to get cheap mortgages to compete for properties.

Economists said it will take multiple interest rate increases – not just Wednesday’s 25-basis-point increase to 0.5 per cent – before borrowing costs rise meaningfully. (A basis point is one-hundredth of a percentage point.)

“I don’t think 25 basis points alone would have much of an impact on the housing market. It will take a series of rate increases to achieve that,” said Jean-François Perrault, chief economist with Bank of Nova Scotia.

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Bank of Montreal chief economist Douglas Porter said it is unlikely that Wednesday’s rate hike will have any significant impact on a housing market with as much momentum as Canada’s. “I suspect rate hikes would really begin to bite when we get to 100 basis points,” he said.

The rate was raised as home prices continue to hit new record highs month after month. In the Toronto region, the country’s largest real estate market, the typical home price jumped $354,000 or 36 per cent to $1,340,000 in the 12 months to February, according to the local real estate board. In the Vancouver region, the typical home price was up 21 per cent year-over-year to $1,313,400, according to the local board.

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Since the COVID-19 pandemic started, home prices have climbed at a record pace, with homebuyers looking for roomy properties in the suburbs and smaller cities where home prices are somewhat cheaper.

Over the past two years, the typical price of a home in Canada is up 48 per cent to $836,300, according to the Canadian Real Estate Association’s home price index, with less populated areas, such as Cambridge in Ontario, Halifax and Chilliwack in B.C., unaccustomed to dealing with unrelenting competition.

“It’s very desperate here,” said Kelli Tynes-Harrington, realtor with Royal LePage Atlantic, who has sold homes in the Halifax area for nearly two decades.

Ms. Tynes-Harrington does not think an incremental increase in interest rates will deter buyers. She said for most of the pandemic, there have been multiple bids on every property. That kind of competition was unheard of prior to the start of the pandemic.

“There’s so many buyers out there that are frustrated with just the lack of inventory,” she said. “Many are just struggling to even find something.”

In announcing its decision to raise the overnight lending rate, the Bank of Canada pointed to Russia’s invasion of Ukraine as a major new source of uncertainty, in addition to continuing problems caused by the pandemic. However, with the Canadian economy continuing to grow and inflation soaring well above the central bank’s target of 2 per cent, the bank’s governing council said it expects interest rates will need to rise further.

The central bank did not indicate when it would raise rates again. It mentioned housing only once in its Wednesday press release, saying “activity is more elevated, adding further pressure to house prices.”

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Scotiabank’s chief economist Mr. Perrault said “it isn’t inconceivable that a first rate hike might actually add to pressures in the market as homebuyers rush into buying ahead of even higher interest rates down the line.”

Frances Hinojosa, mortgage broker and president of Tribe Financial Group, agreed, saying Wednesday’s rate hike will likely have a “psychological impact” and “cause buyers to rush into the market.”

The rapid rise in home prices has motivated would-be buyers to quickly make offers for fear of getting priced out of the market. Now, prospective buyers are racing to make their purchase before mortgages get more expensive. That was the case for Sarah Grant and her husband. For most of last year, they were looking to buy a bigger property in Toronto for their family of four.

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Ms. Grant said they felt pressure to buy before interest rates increased and ended up forgoing Toronto and buying a house in Kelowna, B.C., without viewing the property in person. “It was definitely one factor that was on our mind when we acted quickly,” she said.

Although fixed mortgage rates are higher than they were last year, they are still near historic lows. Wednesday’s change will not affect homeowners who are already locked into a fixed-rate mortgage. If a borrower has a variable-rate mortgage, which is typically pegged to the Bank of Canada’s overnight rate, a higher share of their payments will go toward paying interest instead of the principal.

Within hours of the announcement, most of the country’s largest banks raised their prime lending rate by 25 basis points to 2.7 per cent, effective Thursday. The higher prime rate will bump up borrowing costs on variable-rate mortgages, home equity lines of credit and other lines of credit.

The last time the Bank of Canada embarked on a series of rate increases was after the 2016 real estate boom in Toronto and Vancouver. Over the subsequent two years, the central bank raised the overnight rate five times to 1.75 per cent from 0.75 per cent. The higher borrowing costs, combined with tougher mortgage qualification rules and foreign buyer taxes, helped to calm the market frenzy in Toronto and Vancouver.

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