One of the country’s largest banks sees Canadian real estate getting out of control, and it can hit the whole economy. Scotiabank warns the Bank of Canada (BoC) needs to hike rates soon, or real estate and inflation will get out of control again. Failing to do so won’t just drive home prices higher, but also inflation and the risk of economic instability. Let’s see what these wacky bankers are on about.
Bank of Canada Should Hike Rates To Throttle Real Estate Surge
The Bank of Canada (BoC) has one primary objective—to create stable inflation. Housing shouldn’t be a concern when making decisions, but it was when they drove the country’s real estate frenzy. Households carrying high debt loads also drove the central bank’s decision to pause rate hikes. As a result, real estate investors see the market as protected by the central bank, igniting a second wave of activity.
“The BoC should definitely pay attention to housing, whatever others think,” argues Derek Holt, head of Capital Markets Economics at Scotiabank.
He adds, “Macklem guided in April that the BoC expected a rebound in housing in the second half of the year, yet, as chart 3 vividly depicts, that is already happening.”
Scotiabank’s numbers show substantial growth when it comes to home sales. Seasonally adjusted monthly growth in April for home sales surged in Toronto (+27%), and Vancouver (+24%). May also followed with even further growth—a rapid acceleration for such a brief period, and it’s all related to eroding interest costs.
“Some folks won’t like this but in my professional opinion Canada needs monetary policy and macropru[dential] tools to further tighten the screws,” he argues.
Canadian Real Estate Can Become A Big Driver of Inflation Again
Holt emphasizes that housing is also a driver of inflation, and a drag on economic growth. “[The concern is] not only housing’s direct and indirect contributions to CPI, but also housing’s contribution to growth and the overall output gap framework,” he explains.
Shelter, both rents and mortgage payments, are factored into the CPI directly. BMO has previously pointed out, the measure used lags, and isn’t a reflection of reality, but that’s not today’s point. It’s a direct contributor to inflation, and it’s reigniting again.
Canada Faces Greater Instability Risks With Higher Prices
Holt further argues the BoC needs to pay attention to housing due to economic stability (or the lack thereof). “Housing also matters from the standpoint of driving stability concerns,” he said.
“I still think is more about stability risks due to unfettered housing strengths rather than exaggerated downside concerns.”
He doesn’t dive into the stability issue further than inflation, but there are significant concerns with “bubbles.” Beyond a workforce without stable shelter, the higher shelter costs rise, the more money spending is diverted from other industries. It serves up both a hit to other industries, while also making the country more dependent on shelter.
“The stability risks of allowing this to get out of hand once more outweigh the downside risks that an over-leveraged minority tail of households pose to the outlook,” said Holt.
Bank of Canada Can’t Count On The Fed
Holt sees housing as a problem the BoC played a significant role in causing, and needs to resolve.
“In my opinion, the BoC has played a role in past bouts of runaway gains in house prices with rates that were too low for too long and it is very much within its scope of influence to do something about it in the context of its overall inflation forecasting framework.”
He’s not alone in that thought. The Bank of International Settlements (BIS), the central bank for central banks, produced research that found the recent home price surge was due to rates being “too low for too long.” Heck, even BoC execs have said that lower rates helped to create higher home prices for the past 30 years.
Holt acknowledges that non-monetary policy levers should have been used to tame the demand. However, the failure of the Federal government has turned into the BoC’s inflation and economic risk problem.
“It [the Bank of Canada] cannot count upon other policy levers to do so since, to be totally candid, the country’s policymakers get an ‘F’ for consistently applying excess stimulus to housing demand while paying short shrift to the supply side of the picture,” he explained.
Waiting for the Fed’s heart to grow three sizes, and change course isn’t just unlikely. It would take too long to get to market to prevent the resurgence occurring months before the BoC anticipated. Plus, the Fed quietly rolls back any potential demand throttles almost right after the press conference is done.
“Any further delay in raising the policy rate would only fan housing imbalances to a greater degree and the BoC would be allowing one of the most interest-sensitive sectors that used to be a drag on growth return as a significant driver of growth and with that inflationary pressures,” warns Holt.