The central bank's approach to policy tightening might prove more stringent than the circumstances warrant, analyst warns
The Bank of Canada’s outsized rate hikes could trigger both a significant drop in home prices and a major economic correction, according to Stephen Brown of Capital Economics.
“The Bank of Canada’s recent communications suggest that it will be unfazed by the second consecutive double-digit drop in home sales in May,” Brown said. “This raises the chance of the bank enacting a larger interest rate hike at its meeting in July and leaves us concerned that it will take a more aggressive approach to policy tightening than is ultimately required, driving house prices sharply lower and risking a major recession.”
Slower housing market activity might be “arguably exactly what is required” to rein in inflation, but Brown said that there’s a risk “that the bank will misjudge the impact of its aggressive policy tightening.”
Read more: Key interest rate could rise above 3%, says BoC’s Beaudry
The central bank hiking its overnight rate to 3.5% would lead to an average five-year fixed mortgage rate of 4.5%.
“Even allowing for an acceleration in wage growth this year, an average of those mortgage rates would reduce the maximum house price that a buyer could afford by 23% compared to last year, four times as large an impact as during the prior three tightening cycles,” Brown said.
This would represent the most substantial erosion in affordability since the early ‘80s, Brown warned.
“If so, we would also forecast a steeper decline in house prices than our current assumption of a 10% correction and, rather than GDP growth slowing only to below its potential next year as we currently expect, there would be a real risk of recession.”
