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The dramatic recovery of the resale housing market - with the pace of activity and prices setting another record in October - has some economists wondering if Canada is in the midst of a housing bubble.

Economists at Scotia Capital Inc. are of the view that housing "is becoming an over-valued asset class."

Economist Michael Gregory of BMO Nesbitt Burns, on the other hand, says Canada is in the midst of a "booming rebound" - but not a bubble.

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And Stewart Hall, an economist at HSBC Securities (Canada), says it is too soon to characterize the housing market activity as a bubble yet, but the situation bears watching.

Bubbles are formed when excessive speculation enters a market, pushing prices higher than justified by market fundamentals. However, asset bubbles inevitably pop, leading to sharp price declines.

'This is becoming an over-valued asset class'

"Is Canada in a housing bubble? Probably, but low rates, mortgage innovation and a relative shortage of new supply are likely too keep it going for a while yet," Scotia Capital economists Derek Holt and Karen Cordes said in a research note Monday.

"… Now that last fall's pent-up demand has been released, the three forces of low interest rates, transferring future sales to the present via mortgage innovation, and modest new supply can keep Canadian housing markets humming for some time yet before the eventuality of a softer market on rising rates in a future relative demand vacuum set in."

After CREA released the October numbers, Mr. Holt and Ms. Cordes expanded on their view.

"The Canadian Real Estate Association has reported October sales and prices. The results are a bright spot in the Canadian economy, but with prices up 20 per cent over year-ago levels and at all-time highs by virtually every measure, this is becoming an over-valued asset class in our opinion," the Scotia Capital team said.

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"Flagging rich valuations is not, however, tantamount to predicting anything imminent by way of give-back on prices," the added.

"In fact, they could well push further into record territory next year before risks build."

'Booming rebound, no bubble'

BMO's Mr. Gregory said there is no evidence, at this point, that low interest rates are pumping a domestic housing bubble.

"The record surge in resale volumes reflects unleashing pent-up demand," Mr. Gregory said in a research note. "From mid-2007 record highs (just before the global credit crisis began) to January lows, existing home sales plummeted 42 per cent, with the majority of the decline occurring during the four months after Lehman Brothers' bankruptcy," he wrote.

"Discretionary and big-ticket purchases of all types were postponed in the post-Lehman panic, creating an abnormal amount of pent-up demand…Once the panic subsided, pent-up demand started to unwind, pulled by record low mortgage rates, cheaper home prices (around 9 per cent on average), and an emerging sense among consumers that the worst of the recession was over."

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Prices have since recovered - with October's average sale price reaching a record high of $341,079, the Canadian Real Estate Association said in a report Monday. However, this average was skewed by a surge in activity in the high-priced Vancouver and Toronto markets, noted economist Douglas Porter, also with BMO Nesbitt Burns.

"The rapid-fire rebound in Canadian housing is showing no signs of letting up," Mr. Porter said in a note to clients. "While that may be causing some sweaty palms among bubble-phobes, the quick turn is a vivid illustration that monetary policy still works in this country."

When asset bubbles pop, 'it's rather painful to all and sundry'

Mr. Hall, of HSBC Securities (Canada), said he is not going to "drive up the rhetoric" by suggesting that Canada's housing market has already entered bubble territory.

Noting that the Bank of Canada views the current level of activity as the result of "pent-up demand being burned off," Mr. Hall said he is prepared to wait before sounding the alarm.

"But it certainly bears watching. The real estate market is definitely showing very, very robust levels of activity, particularly at this stage of the business cycle, where we have an economy that really hasn't launched into recovery mode yet."

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If the sales activity merely reflects pent-up demand, rather than an over-heated market fuelled by cheap money, the pace of activity should start to moderate, Mr. Hall said in an interview.

"Beyond 2009 and getting into 2010, if we are continuing to throw off these heightened levels of activity, then I will become quite concerned that we are on the cusp of an asset bubble here…

"And when they pop, it's rather painful to all and sundry."

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