Capital Economics says that the Bank of Canada could potentially set home sales into a tailspin.
There is a sign in front of a home.
The photo was taken by Azin Ghaffari.
Canada could be at risk of a recession if the Bank of Canada gets too aggressive with its rate hikes.
In a Tuesday update, senior Canada economist Stephen Brown said that the central bank seemed unperturbed by a double-digit drop in home sales in May, and that it was adopting an increasingly hawkish tone on inflation.
He said that this raises the chance of a larger interest rate hike at the bank's meeting in July and that it will take a more aggressive approach to policy tightening than is required.
In May, national home sales fell 12 per cent on a month-over-month basis. The balance of supply and demand gave Brown more reason to be concerned.
Home price inflation could be zero by the end of the year if the sales-to-new listings ratio in major markets continues to fall.
According to Capital Economics data, home prices are falling in the country. Toronto's prices fell for the second month in a row in May.
Canada's housing sector took up little space in the bank's policy statement after it raised interest rates by 50 basis points.
The financial system review will be delivered on June 9 and it is possible that it will include more information about the housing market.
As inflation runs at multi-decade highs, the bank has signaled it was ready to get tough on rising consumer prices. The governor of the Bank of Canada suggested in April that the central bank could raise the overnight rate from the neutral range of two to three per cent.
The bank would need to raise its benchmark interest rate to at least three per cent to tame inflation, according to the deputy governor.
Brown argued that the bank's aggressive policy tightening could send home sales into a tailspin.
The housing market would face the most dramatic hit to affordability since the early 1980s if the bank raised its policy rate.
A policy rate of 3.5 per cent would bring the average five-year fixed rate mortgage rate up to 4.5 per cent and the average variable rate to 5.1 per cent, according to Brown. According to Capital Economics, the mortgage rates would reduce the maximum home price buyers could afford by 23 per cent, which is larger than the previous three tightening cycles.
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