Homebuyers have been reaping the benefits of super-low interest rates since the onset of COVID-19. Now, with the Bank of Canada having made its second hike to the overnight rate in what is expected to be a series of increases this year, higher rates could change the trajectory of the housing market.
In a recent RBC Economics report, Robert Hogue, RBC’s assistant chief economist, said that low interest rates have been stoking market demand for years, from bolstering move-up buyers, to opening ownership opportunities for first-time purchasers. With inflation at a thirty-year high now, the BoC is trying to change course by hiking rates significantly over the year, a move that Hogue says will be a “game-changer for the market.”
“We now expect home resale activity to slow more quickly than previously anticipated and, perhaps more important, we see prices peaking this spring as market sentiment sours from extreme bullishness,” said the RBC economist. “In this altered landscape, local markets could experience a mild price correction, partly reversing outsized gains recorded in the past year.”
Rates could rise another 100 bps in six months
Canadians could see the greatest hike to interest rates in the shortest period of time in decades.
The BoC made its first 2022 rate hike back in March, bumping up the target for the overnight rate by 0.25 per cent. A month later, Canada’s central bank increased rates to one per cent, a move that Hogue says “signalled it’s keen to proceed forcefully to raise its policy rate to a neutral level by year-end.”
RBC Economics predicts we could see another 100 basis-point increase over the next six months, sending rates to two per cent or slightly above pre-pandemic levels at 1.75 per cent.
“Canadians haven’t seen this large an increase in such a short period since the tightening cycle of 2005-2006,” noted Hogue.
Higher rates reduce borrowing capacity, leave “no escape”
Since the fall, fixed rate mortgages have been on the rise. However, the impact on borrowing has been fairly soft since more borrowers have opted for variable-rate mortgages, rates for which have been very low. Now that the BoC’s rate hike cycle has begun, variable rates will become more expensive, leaving borrowers with “no escape,” from higher rates.
The rate increase is pushing up the mortgage stress test’s qualifying rate, knocking some buyers from the market. Even for those who do qualify, Hogue pointed out that higher rates will reduce the size of the mortgage they can get.
“For households earning the median income, for example, the rise in fixed mortgage rates will shrink the maximum purchase budget by roughly 15 per cent,” said Hogue. “That will more than reverse the increase in 2020 and early-2021 when declining rates provided substantial added budget room.”
From an affordability standpoint, higher rates will “pose huge challenges,” for homebuyers. RBC’s aggregate affordability measure for Canada has already fallen to a 31-year low and is heading for the worst-ever levels in the coming year or as early as Q3-2022, said Hogue.
The housing policies proposed in the 2022 federal budget won’t provide much help for now, said the economist, as they won’t deliver any benefits for a while or will only offer marginal support.
“We expect poor and worsening affordability to increasingly weigh on homebuyer demand across the country,” said Hogue.
RBC revises housing forecasts for pricing and sales
More aggressive moves from the BoC have caused RBC Economics to revise its housing forecasts.
Now, RBC expects home resales in Canada to drop 13 per cent to 578,000 units in 2022, and fall another 14 per cent in 2023 to 500,000 units. Previously, RBC had anticipated 580,000 unit sales in 2022 and 548,000 sales next year in their previous forecast.
“This implies a significant slowdown over the spring to fall period before sales stabilize in 2023 on a quarterly basis,” said Hogue. “We think this cooling will help the market return to balance.”
Crumbling affordability and higher interest rates will also help to curve home prices. Hogue anticipates that prices will peak this spring before weakening throughout the year, but stronger-than-expected gains made so far in 2022 will push the annual average price for 2022 higher than predicted. Now, the Canadian aggregate benchmark is expected to rise 8.1 per cent, up from 6.2 per cent. The 2023 annual average will likely drop 2.2 per cent instead of rising 0.8 per cent like initially expected.
Canada’s most expensive housing markets will likely feel the pinch of rising rates more than other areas.
“This will translate into larger annual price declines in 2023 in British Columbia and Ontario,” said Hogue. “By comparison, we expect activity and prices to be more resilient in Alberta, where local markets have more catching up to do following a prolonged slump before the pandemic.”
Higher rates may bring welcome market changes
Although rising rates will bring challenges to the market, there are a few positives to bear in mind.
Hogue said that the odds of a market crash are low. Millennials who are entering their prime home-buying years will support demand in the market, as will higher immigration levels. With home supply still chronically low, there are few signs of oversupply or overbuilding in Canada. Housing construction and cooling demand will help to rebalance the market.
“Rather than pose a major threat, we think rising interest rates are likely to bring welcome changes to the market—including more sustainable activity, fewer price wars, more balanced conditions, and modest price relief for buyers,” said Hogue. “After the extreme price increases and heated bidding wars of the last year, this would be a positive shift.”
