Benjamin Tal believes fast interest rate hikes will have a drastic influence on the real estate market

According to CIBC Deputy Chief Economist Benjamin Tal, Bank of Canada needs to take a slow and cautious approach to interest rate increases, otherwise it will damage Canadian mortgage holders.

According to him, delicate touch is necessary for making sure the pace of interest rate hikes will not cause financial disasters for homeowners.

“The main risk for the real estate market right now is the potential scenario when the BoC waits for too long and then starts raising rates too quickly, for instance, in 2023. It will be devastating for the market,” – he noted.

“So we hope the Bank will act early and slowly, thus reducing the hit for the mortgage market and the real estate market. In my opinion, the fact that the central bank has made it clear it plans to start raising rates in the second half of 2022, (much earlier than expected only a few months ago) is a great sign”.

The BoC has reiterated recently that it will not raise its key lending rate until the economic recovery from the pandemic has stabilized. It said there’s a possibility it could happen in the second half of the next year.

Historically low interest rates aimed at supporting the domestic economy during the pandemic also had the side effect of overheating Canadian housing markets. Moreover, the heat hasn’t been limited by usually hot markets of Toronto and Vancouver with their average home prices exceeding $1 million. Due to remote work trend, people started looking for larger properties further.

As a result, we’ve seen double-digit price gains in such Toronto bedroom communities as Brampton and Oshawa.

Such price increases combined with extremely low rates have helped Canadians secure larger mortgages. According to Tal, it has led to conditions where homeowners are more sensitive to any rate hikes than ever.

“Obviously we need to ask to what extent people are sensitive to the risk of higher rates. And the short answer is ’very sensitive’,” – he noted. “We are facing a record high level of sensitivity. Based on my estimates, a 1% rate increase today is almost 30-40% more effective than only a few years ago. The sensitivity of households to rate hikes has risen significantly.”

Due to low interest rates and sky-rocketing home prices, Canada has started relying even more on the residential housing sector, which now accounts for more than 10% of the total economic output. In Tal’s opinion, without a steady hand, the BoC may lead Canada into another recession with too fast increases.

“Every economic recession was helped, or even caused, by a monetary policy error in which central banks were increasing interest rates too quickly, and we need to avoid it,” – he said.

“We know inflation will go up, but we don’t know for how long. It will go up, and if we wait for too long, then rates will be raised too quickly at some point. It’s not about the fact of rate hikes, but about the pace of the increase cycle”.