Bank of Canada worries a rate cut now could overheat the spring housing market

The Bank of Canada is trying to thread a needle. It's keeping rates higher for longer at least in part because it's worried a rate cut now could undermine the last two years of pain and progress.

"We don't want to keep monetary policy this restrictive for longer than we have to. But nor do we want to jeopardize the progress we've made in bringing inflation down," said bank governor Tiff Macklem.

On Wednesday, the Bank of Canada announced it would hold its key interest rate at five per cent, where it has stayed since July.

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One key cause for concern is a housing market that's showing signs of heating up. The benchmark average home price in Canada is down more than 17 per cent from its peak in 2022. But the numbers for December and January indicate the market may have bottomed out and started to rebound.

"Sales are up, market conditions have tightened quite a bit, and there has been anecdotal evidence of renewed competition among buyers," said Shaun Cathcart, senior economist with the Canadian Real Estate Association.

Macklem says the central bank is keeping a close eye on how the housing market behaves. In a news conference on Wednesday, he said his projections show the market is already picking up speed. He's worried that could accelerate.

"Could that rebound be stronger than we've expected? Yes, it could," he said. "And that is an upside risk."

The question is what may happen if the Bank of Canada cuts rates now, just as the housing market is heading into the spring — which usually sees a surge in activity.

"A rate cut would add fuel to what is already looking like a hot spring market," said James Laird, co-CEO of Ratehub.ca and president of CanWise mortgage lender. "The Bank of Canada will be hesitant to stoke demand in the housing market, given how unaffordable housing already is."

The Bank of Canada has been hiking interest rates since March 2022. As rates rose, debt payments grew more expensive. Households were squeezed, so they spent less. That cooled the economy and helped bring supply and demand back into balance.

Now, though, inflation is almost all the way back down to the bank's target of two per cent. The year-over-year rate eased to 2.9 per cent in January. 

WATCH | Bank of Canada governor explains core inflation: 

'Why do we care about core inflation?' Bank of Canada governor explains

9 months ago

Duration 1:54

Tiff Macklem, governor of the Bank of Canada, says core inflation — which strips out volatile parts of the consumer price index — gives the bank a sense of where the trend is.

But shelter costs remain the biggest contributor to price growth. Mortgage interest costs are up more than 27 per cent. Rent prices grew just shy of eight per cent.

Cutting rates would help bring down those costs. But economists warn it could also have unintended consequences.

"I do think they're going to be kind of reluctant to be cutting around the spring housing-buying season," said Veronica Clark, an economist at Citi in New York.

Real estate agents tell CBC News that they have buyers on the sidelines, poised to jump back in as soon as rates start to fall.

"Everybody is waiting patiently [for a rate cut]," said Michael Emmett, a Toronto-based realtor with Royal Lepage Terrequity. 

Once the bank starts to cut, he says buyers will flood back into the market, driving up prices again.

"I believe it would go like gangbusters," he said.

Real estate isn't the only thing keeping the central bank from cutting. Macklem pointed to persistent price growth in core measures of inflation that strip out more volatile components. He says too many categories are still posting price growth above three per cent.

"We know everybody would like to see lower inflation and lower interest rates. So would we," said Macklem. "But we need to balance the risks of keeping monetary policy this restrictive for too long against the risks of lowering prematurely and jeopardizing the progress we've made."

Right now, the bank's forward guidance is focused on the risks that progress could be undermined.

The central bank's next decision in April will be accompanied by a fresh set of forecasts for economic growth. By then, new consumer price index data, as well as new figures on home sales and GDP growth, will shed new light on the fight to rein in inflation.

Will that be enough to nudge the bank's forward guidance toward an indication that it will ready to cut sometime this summer? Macklem remained vague.

"We don't give forward guidance on our forward guidance," he said.