Housing market to lose momentum as bond yields rise - Capital Economics
Canada Economics

Housing market to lose momentum as bond yields rise

Canada Economics Update
Written by Stephen Brown
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Record low inventory should continue to drive strong house price gains in the first half of the year, but we expect house price inflation to slow beyond then as bond yields and mortgage rates start to rise.

  • Record low inventory should continue to drive strong house price gains in the first half of the year, but we expect house price inflation to slow beyond then as bond yields and mortgage rates start to rise.
  • Home sales rose by a further 2% m/m in January, whereas new listings fell by 13% m/m. The dearth of new listings seems to have been due to the lockdowns in Ontario and Quebec, where they plunged. The sales-to-new listings ratio is therefore set to drop back from its extraordinarily high level now the restrictions are being eased, but it will almost certainly continue to point to strong house price gains. (See Chart 1.)
  • While prices should rise strongly in the first half of 2021, the market will soon have to contend with higher interest rates. We still think the Bank of Canada will keep its policy rate at 0.25% until 2023, but we have changed our assessment of inflation breakevens now the global vaccination process is underway and governments, at least those in North America, are still eyeing further stimulus. We now expect Canada’s 10-year bond yield to rise to 1.5% this year and 1.75% in 2022, from the current 1.1%. (See here.)
  • Mortgage rates will depend not only on banks’ funding costs but also lending spreads, which have narrowed in the past year. Our yield forecasts imply the five-year fixed mortgage rate will rise from 1.8% to 2.3% if the spread were unchanged, or to 2.8% if the spread returned to the pre-pandemic norm. (See Chart 2.)
  • We doubt either scenario would send house prices into reverse. If the outcome lies in the middle, then the price that a median-income household could afford would drop by only 3%. (See Chart 3.) Moreover, the recent market strength has been driven disproportionately by cities where affordability remains favourable, including Montreal, Ottawa and places outside of Toronto such as Hamilton. (See Chart 4.)
  • Nevertheless, prices are now very stretched relative to incomes in certain segments of the market such as for single-family homes in Toronto and Vancouver, so a rebound in mortgage rates is likely to reduce demand meaningfully in some areas. As a result, we expect house price inflation to slow from an average of 10% in the first quarter to 5% by the end of the year, and to little more than 2% by the end of 2022.

Chart 1: Sales-to-New Listing Ratio & House Prices

Chart 2: Bond Yields & Mortgage Rates (%)

Chart 1: House Price that Medium-Income Household Can Afford ($000)

Chart 2: House Price Gains Since February 2020 & Current Affordability by City

Sources: Refinitiv, CREA, RateSpy.com


Stephen Brown, Senior Canada Economist, +1 416 874 0514, stephen.brown@capitaleconomics.com