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Will the Bank of Canada raise rates to combat soaring house prices?

Canada is grappling with a housing market crisis that has seen the median family home soar 20% in a year to C$720,850. As inflation surges, will the Bank of Canada raise interest rates in 2022?

USD/CAD is one of the most popular currency pairs on IG. And currently, 56% of clients are long on the market, signalling investor uncertainty as the markets price in the chances that the US Federal Reserve could raise rates before the Bank of Canada. But as its housing market rises out of control, Canada’s central bank is coming under intense pressure to tighten monetary policy.

USD/CAD: Inflation and interest rates

According to this month’s renewal of Canada’s Monetary Policy Framework, ‘the primary objective of monetary policy is to maintain low, stable inflation over time.’ And in common with every central bank across the western world, the Bank of Canada has struggled with this mandate in 2021.

Canada’s CPI inflation rate is at a multi-decade high of 4.7%. This may be lower than the US’s 6.8%, the UK’s 5.1%, and the EU’s 4.9%. However, Canada’s central bank is tasked with preserving the inflation rate at between 1% and 3%— and inflation is expected to continue rising until mid-2022.

But at its December interest rate meeting, the bank decided to hold the base rate at 0.25%, citing how the Omicron variant has ‘injected renewed uncertainty,’ and that ‘accommodative financial conditions are still supporting economic activity.’ Much like the Federal Reserve, it has also dropped the word ‘transitory’ to describe the current inflationary spiral.

Justifying its decision, the bank said that ‘Canada’s economy grew by about 5.5% in the third quarter…GDP is about 1.5% below its level in the last quarter of 2019 before the pandemic began.’

Meanwhile, Statistics Canada’s November Labour Force Survey found that ‘the unemployment rate fell to 6.0%, within 0.3 percentage points of what it was in February 2020.’ And the country had 912,600 job vacancies, a record high.

The bank summarised that it remains ‘committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2% inflation target is sustainably achieved…sometime in the middle quarters of 2022.’ However, maintaining this ultra-loose monetary policy will come at a cost.

USD/CAD: red-hot housing market

Across the western nations, rapidly rising housing costs is fast becoming a crisis. Wage increases are being eclipsed by house price rises— and arguably, the Great White North has been one of hardest hit.

The Canadian Real Estate Association estimates that the national average home price rose 19.6% over the past year to C$720,850 in November 2021. And according to Royal LePage CEO Phil Soper, prices will rise a further 10.5% in 2022, due to ‘to a level of demand that will continue to outpace inventory, keeping prices rising on a steep upward trajectory.’

With average prices in Toronto and Vancouver already surpassing the C$1 million mark, Soper believes the increases will continue as buyers take ‘advantage of increased savings and record-low interest rates.’ Prices will also be supported by high immigration and the continued transition to remote working.

After failing to win a majority in September’s snap election, Prime Minister Justin Trudeau has instructed Housing Minister Ahmed Hussen to discourage property investment by reviewing the rules around deposits as well as housing policies to curb ‘excessive profits.’

Hussen plans to ‘reduce speculative demand in the market and help cool these astronomical increases in prices.’ He has already imposed a 1% tax on foreign-owned vacant homes and intends to ban the controversial practice of blind bidding. He is also proposing C$4 billion for affordable housing but has come up against ‘NIMBYism’ and ‘unreasonable opposition to affordable housing in neighbourhoods.’

New Zealand implemented similar laws to stop property speculation back in March. However, average prices still rose 31% over the year to July to a record NZ$937,000. Its Reserve Bank has finally increased its base rate to 0.75% and plans for further rises in the new year.

But Conference Board of Canada economist Sasan Fouladirad believes that Canada will not raise rates before the US, as ‘Canadian household debt is on average much higher than the US…we expect the Bank to wait until June next year.’

However, as housing inflation continues to skyrocket, the argument for raising rates continues to grow stronger.

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