As Chief Economist, Bob Dugan leads teams of housing economists and researchers. They strive to improve Canada’s understanding of drivers and barriers in housing markets and how they impact affordability. Recently, changes have been happening at a swifter pace – when this happens, Bob and our experts will provide timely updates to complement regularly published reports.
Chief Economist at Canada Mortgage and Housing Corporation (CMHC)
Inflation in Canada has reached its highest level in nearly 4 decades prompting moves to raise policy interest rates with further hikes to come. The attention for many turned to what this means for future housing activity. Most important concerns focus on:
- what this means for the outlook for house price growth in Canada
- the industry’s ability to accelerate housing supply to begin restoring housing affordability in this country
Here, we try to answer some of these important questions and look at how different policy interest rates and economic scenarios will impact housing activity.
How will different interest rates and economic scenarios play out?
During the COVID-19 pandemic, household demand recovered rapidly after the initial sharp declines. However, the supply of goods and services has not matched demand recovery.
The war in Ukraine drove up energy and commodity prices, while China’s zero-COVID policy caused further supply chain disruptions. Both external factors have contributed to rising inflation.
The Canadian economy has rebounded from the pandemic. Strong economic growth and strong job creation have caused the unemployment rate to drop to an all-time low of 4.9%. As of early 2022, the Bank of Canada estimates that demand for goods and services is becoming greater than what the economy can produce in Canada1.
This excess demand is a key source of upward pressure on inflation. To contain inflation, the Bank of Canada raised its policy interest rate 3 consecutive times, totaling 125 basis points from March to the end of June 2022. The current consensus among economists predicts further policy interest rate hikes from the Bank of Canada.
Because of the pervasive uncertainty, CMHC developed 2 scenarios to understand potential impacts on housing: a moderate and a high interest rate scenario.
The moderate scenario details a policy interest rate that reaches 2.5% by early 2023 and then stays at that level until the end of 2025. At 2.5% the policy interest rate reaches a level that is neither stimulating growth in the economy nor causing it to contract (the neutral policy rate).
In this scenario, the moderate rise in interest rates is assumed to be sufficient to control inflation given the sensitivity of households to rising rates due to their large debt loads.
In the high interest rate scenario, more actions by the Bank of Canada are required to prevent excess demand from triggering spiraling prices and wages in response to higher inflation expectations. This more aggressive response would be needed to slow growth in the economy, which allows excess demand to dissipate and allow inflation expectations to moderate and to bring overall inflation back to its 2% target.
In this scenario, the Bank of Canada hikes more aggressively and increases its policy interest rate to 3.5% in early 2023 before gradually converging back to the neutral rate of 2.5%. In both scenarios, inflation gets back to the 2% mark by the end of 2023.