Canadian State of the Housing Market, November Recap

In the speech “Economic progress report: Immigration, housing, and the outlook for inflation,” Gravelle took time to stress that Canada’s newcomers have had “barely any effect on inflation—less than 0.1 percentage points,” as newcomers both produce and purchase products. However, the bank does indeed see an impact on shelter price inflation, meaning rent and house prices.

“Newcomers don’t just consume goods and services, they also need a place to live,” said Gravelle, “and this is where we do see pressure on inflation.”

Gravelle notes that this trend is evident in the job vacancy rate post-2015, coinciding with an upswing in immigration and a job vacancy rate decline, reflecting a worsening of long-standing imbalances in the housing market. “When newcomer arrivals picked up sharply in early 2022, that steady decline in the vacancy rate became a cliff,” said Gravelle.

This is apparent in the data presented in Chart 5 of the economic progress report, showing a substantial drop in the job vacancy rate post-2022, provoking a heightened demand for additional housing. Additionally, in the aforementioned “Assessing the effects” study released by the BOC, Chart 7 shows that demographic demand for housing has far outpaced housing construction during the pandemic, resulting in a decrease in the number of households from 2020 to 2022.

This is a well-recognized but misunderstood issue, synergistically articulated by several sources, such as this Better Dwelling article from December 16th, 2021, which claimed that housing supply wasn’t the cause of price hikes but rather a rise in demand driving higher home prices. Further, a Financial Post article from September 24th, 2021, said that Canada’s increasing housing prices are propelled by the growing population, while an April 16th, 2022, CBC article pointed out that interest rate hikes, meant to help quell supply issues and cool housing market damage caused by inflation, are doing nothing but raising housing prices.

Therefore, low housing supply, rising home prices, increasing demand, and high mortgage rates were working in unison, rather than one singular factor. For example, sources that once attributed the pandemic price boom almost solely to housing supply now acknowledge the trajectory of home prices and interest rates, attempting to back up their predictions with economic data due to the effects of inflation. 

Inflation, it turns out, is the radical culprit.

Regardless of the timing, Gravelle says that the low job vacancy rate is now putting upward pressure on the shelter component of the Consumer Price Index (CPI). “The housing imbalance also has serious consequences for shelter price inflation, which accounts for about 25 percent of the CPI basket,” said Gravelle.

Gravelle understands that housing issues are a complex bundle of vibrating economic forces but points out that mortgage interest costs are the primary driver of inflation. This was first reported in a Financial Post article from May 16th, focusing on CPI figures that suggested surging mortgage interest costs and rising immigration was fueling inflation, ultimately contributing to the rise in housing prices and negatively affecting affordability.

In Gravelle’s “Assessing the effects” speech, he noted that when the bank raised interest rates, they expected more significant decreases in other parts of the shelter component, meaning lower house prices. This would have offset the increases in the CPI stemming from mortgage interest costs. However, house prices didn’t fall as much as the BOC anticipated. This echoes the sentiment expressed by the BOC in an October 25th article from The Globe and Mail, stating that their anticipation of higher interest rates causing house prices to drop had not happened “because a shortage of homes in the country is keeping values elevated.”

Chart 6 in the economic progress report previously mentioned shows the difference between rent inflation in Canada and the United States. One of the main reasons for shelter inflation is outlined by Gravelle: “The bigger issue is that Canada’s housing supply has not kept pace with recent increases in immigration.” The BOC, in hiking rates to five percent, had assumed a more substantial and rapid decline in house prices. However, the institution was surprised to find that this didn’t occur, due in part to higher levels of immigration.

As mentioned earlier, the release of Gravelle’s speech coincided with the release of the BOC Staff Analytical Note, which sought to uncover how immigration contributes more to house price inflation in Canada compared to other countries. According to the study, the divergence arises because immigration causes more house price inflation in Canada than elsewhere, primarily due to newcomers being less likely to enter the construction industry in Canada. This results in fewer houses being built to accommodate the rising demand for shelter. 

The study uses the United States as an example, noting that despite having a large number of newcomers, the U.S. experiences less house price inflation. Only about five percent of Canada’s non-permanent residents (NPRs) enter the construction profession compared with the sector’s eight percent slice of total employment.

That being said, the BOC Staff Analytical Note couches its conclusions in footnote eight, pointing to a single 2020 academic article titled “Immigration and Wage Dynamics: Evidence from the Mexican Peso Crisis.” The article suggests that in countries where immigration works to increase housing supply, there is not an increase in house prices in the medium to long term. The article examines Mexican immigration to the United States, which contributed to housing inventory. This process helped offset demand by creating more supply, and while this notion may be valid, it’s important to note that only one cited academic source still raises conclusive doubt.

As noted in Gravelle’s speech and the Staff Analytical Note study, the BOC’s decision to raise rates over the past few years was expected to result in a more substantial decline in house prices than what actually occurred. A November 1st CTV News article confirms that home prices didn’t fall as much as was anticipated due to immigration. The article notes that “The federal government plans to level out the number of new residents to Canada in 2026 in reaction to [the] crunch on housing and other services.”

According to a November 21st yahoo!finance article, there is an expectation that the BOC will lower interest rates in short order, maybe even in time for the spring market. However, the BOC opted to release Gravelle’s speech and the Staff Analytical Note, stressing that inflationary pressures are being caused by the housing market. 

The BOC’s decision to release these documents indicates their awareness of the potential impact on real estate prices when rates are dropped, which was articulated by Holt in his aforementioned interview with Bloomberg:

“He [Gravelle] put a lot of emphasis upon the role of immigration, tight housing markets, and shelter cost inflation being under upward pressure as a major component of the CPI basket,” said Holt. “To me, the takeaway there was ‘Don’t count on us to cut interest rates when that’s our worry going into the spring housing market.’”

So, the BOC is well aware of the stimulative pressure put on the economy, particularly within the real estate market, when it lowers interest rates. This is why the BOC decreased rates in 2020 and 2021. According to an IMF blog dated January 27th, 2022, lowering interest rates tends to drive up asset prices, barring a major economic downturn. Although low interest rates support higher asset prices, risks rise with unpredictable and sudden hikes in interest rates. In addition, the nearly prescient IMF report states:

“Looking ahead, with persistent inflation, central banks face a balancing act. All the while, real interest rates remain very low in many countries. Monetary policy tightening must be accompanied by some tightening of financial conditions. But there could be unintended consequences if global financial conditions tighten substantially. A higher and sudden increase in real interest rates could lead potentially to a disruptive price revaluation and an even larger selloff in stocks. As financial vulnerabilities remain elevated in several sectors, monetary authorities should provide clear guidance about the future stance of policy to avoid unnecessary volatility and safeguard financial stability.”

Of course, Pandora’s box has been opened. The Canadian economy, along with its housing market, currently exists in a vulnerable state not experienced in quite some time. As such, the collective message from Gravelle, from the BOC Staff Analytical Note, and Holt at Scotiabank is clear: unless a major economic recession occurs, don’t expect rate cuts in time for the spring housing market.

Therefore, the BOC only needs to cut interest rates if the Canadian economy experiences a severe downturn. That being said, according to a December 1st article from The Globe and Mail, while rate cuts are indeed possible in 2024, Canadians should not expect them with a 5.8 percent unemployment rate.

To counter, according to the December 15th MarketWatch graph data, yields on government bonds are plummeting at 3.245 percent. And, as reported in a December 7th Financial Post article, falling fixed mortgage rates indicate a possible interest rate decrease. 

However, the simultaneous release of Gravelle’s speech and the staff report by the BOC appears intentional. It suggests the BOC is refusing to endorse a view that rates have peaked, leading toward a pivot that espouses looser monetary policy.

According to The Globe and Mail article from December 7th, Gravelle stated that “the bank needs to see a decline in core inflation, slower wage growth, falling inflation expectations, and more normal corporate price-setting behaviour before considering rate cuts.” 

In our December recap, HAVEN will take a further look at the numbers: how Canada’s housing market is reacting to prevailing economic factors influencing real estate.