Canadian real estate prices are soaring due to demand, but how much of it is excess? That’s a question BMO tackled in its latest research note, looking at home sale dollar volumes. The bank estimates excess demand driven by the central bank is now the size of 6 points of gross domestic product (GDP). Remember, that’s just the excess demand. The stimulus has driven the cost of housing significantly higher, with the bank seeing no relief until the central bank hits the breaks.
Canada’s “Excess” Demand For Housing Is Now 6% of GDP
Canada went all-in on housing to the point where just the excess sales are now the size of a small country’s economy. The value of home sales through the MLS reached $500 billion annualized in October. Using the past 15 years of data to establish a trend, BMO estimates there is currently $150 billion per year in excess demand.
It’s as big as it sounds — that’s an astronomical amount of excess demand. The extra home sales above and beyond normal is nearly half the size of Toronto’s GDP. “…a cool 6% of GDP on top of what would otherwise be considered about normal,” said Robert Kavcic, a senior economist at BMO.
The Value of Canadian Existing Home Sales Vs The Trend
Adding, “… in fact, the amount of ‘excess’ dollar volume now in the market is almost equivalent to an entire good year overall during the 2010-to-2015 period.”
Excess Demand For Canadian Housing Is Pushing Prices Higher
Excess demand plays a significant role in driving home prices higher. It’s often said there is low residential real estate inventory. However, inventory has shown stable growth over the past few years.
Inventory is just struggling to keep up with the recent elevated demand. It’s not a new normal for demand either, despite the assumption by some experts. This has been largely stimulated by policymakers looking to create demand.
The Bank of Canada’s Role In Stimulating Excess Demand
The Bank of Canada (BoC) has one primary goal and that’s to keep inflation low and stable. It does this by making sure credit growth is sufficient to produce its target interest rate of 2%. The primary way it manages inflation is by influencing the cost of debt by the overnight rate.
When inflation is low, central banks generally cut interest rates to stimulate borrowing. The goal is to make credit cheap enough that people are incentivized to borrow to buy large goods, such as homes. By doing this, they’re hoping to create enough demand to push inflation to the target rate. The stimulated demand is often pulled forward from people who can now borrow more money.
When inflation is too high and credit is growing too fast, the BoC raises interest rates. By doing this they’re making credit more expensive in an attempt to dampen the desire to borrow. This reduces buyer demand and relieves pricing pressure, lowering inflation. Most demand doesn’t disappear permanently but is delayed as they save more to buy.
In the current environment, the stimulus of a rate cut isn’t enough demand. The central bank has also been using quantitative ease (QE) on top of the cut. This is when it buys government bonds with the goal of driving yields lower. By doing this, they’re also driving the cost of borrowing debt lower. It serves a similar function to rate cuts, where they’re trying to drive inflation higher.
Canada Is Addicted To Cheap Economic Growth
What happens when a central bank disregards its data and begins to chase political goals? The BoC didn’t wait for data when the pandemic began, it took a guess at how much was needed. They slashed rates and bought billions in mortgage bonds before the impact was felt.
If you think forecasting a housing crash is silly, you’re going to love this. The BoC didn’t just forecast a housing crash — it forecast one and then used billions in capital to fix it before it happened. They were wrong about the crash but only because they created excess demand and then some.
They must be trying to correct an overstimulated economy, right? QE only ended two weeks ago and the overnight rate is still incredibly low. In fact, the last time the economy (both GDP and unemployment) was at this level in 2017, they began to raise rates. For some odd reason, they aren’t really into that. Back then, this data point was so strong it needed a bucket of cold water dumped onto it. Fast forward to the same data with record inflation and the BoC thinks it looks disastrous.
BMO seems to agree with the assessment that these mechanics appear to be abused. “We’ve said it before, and we’ll say it again. This is only going to cool when the BoC says so…,” ended the research note.