When the Bank of Canada cut its overnight lending rate by 25 basis points last week, the response from housing experts largely fell into two camps: those who believe that relaxing interest rates will buttress the struggling real estate markets, and those who believe the cut is not large enough to influence market outcomes this summer.

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Will the Bank of Canada's interest rate cut spur the housing market? Back to video

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Housing markets are extremely sensitive to movements in interest rates, which subsequently affect mortgage rates and monthly mortgage payments. In the past, housing sales have reacted strongly to changes in rate regimes. Therefore, estimating the likely impact of declining rates is paramount for lenders and mortgage-seekers.

Regional housing markets from coast to coast contribute to the national housing portrait. While regional deviations from national averages are meaningful in local decisions, the overall impact of interest rate movements needs to be examined at the national scale.

The latest data from the Canada Real Estate Association (CREA) suggests that April 2024 sales have been considerably lower than the peak sales recorded in early 2021. COVID-19 is mostly responsible for post-pandemic large swings in sales and prices.

What are the implications of adopting a long-term perspective on the markets? Interestingly, April sales are mostly in line with the pre-pandemic longer-term trend of 40,000 seasonally adjusted monthly sales. Equally important is the realization that housing sales have been mostly below the long-term average of 40,000 sales since June 2022. If the pre-pandemic average trends would have continued, one can estimate a shortfall of approximately 70,000 sales since June 2022.

With a supportive environment, new homebuyers — those who were previously inactive — as well as individuals who had deferred purchasing in anticipation of more favourable interest rates are likely to re-enter the market this summer in search of deals. This pent-up demand is expected to drive both sales and, to some degree, prices higher than what has been observed in the recent past.

Homebuyers will be greeted with an abundance of choice. New listings have been growing since the third quarter of 2023, and the sales-to-new listings ratio has been under 60 percent nationally for almost a year. The downward trend in recent months suggests that sellers are anticipating an increase in demand and have entered the market sooner than buyers.

The assertion that interest rate cuts push housing prices higher is mostly accepted in the economics literature, though research questioning this notion is also available. Analyzing the impact on housing prices from both short- and long-term perspectives may yield divergent conclusions. In the short term, it’s clear that the average housing prices in Canada currently sit below the peak reached in early 2022.

The long-term view, drawn by extrapolating the trend in average price growth in Canada from 2005 to just before the pandemic, suggests that current housing prices are significantly higher than their long-term average trend. The expected increase in prices, albeit moderate, because of the rate cuts will keep prices much higher than their expected long-term trends, which may exert downward pressure on the growth in sales this summer.

Earlier research in housing markets suggests that the impact of rate cuts is moderated by the expectations of future price appreciations. Writing in the Journal of Real Estate Finance and Economics in 1989, Jack C. Harris explained that homebuyers are motivated by the future expectations in prices, which rise when interest rates are low or are expected to decline. Future expectations remain “influential during periods of declining and moderating real prices, not just when prices are rising,” noted Harris.

Recent research by Gregory D Sutton and others for the Bank of International Settlements confirmed that, unlike sales, housing prices are rather sticky. They concluded that “changes in interest rates and other determinants affect house prices gradually rather than on impact. This suggests that modest cuts in policy rates are not likely to rapidly fuel house price increases.”

The Bank of Canada will periodically revisit its decision on mortgage rates in July, September, October, and December as the Bank will closely monitor inflation. Interestingly, any increase in housing prices, brought about by lower borrowing costs, is likely to influence inflation and may provide the central bank with reasons to reflect further.

If buyers expect future housing prices to rise, the summer housing market is likely to experience a higher sales volume. Thus, even moderate rate cuts will influence sales volume in the short term, if not prices.

Want to know more about the mortgage market? Read Robert McLister’s new weekly column in the Financial Post for the latest trends and details on financing opportunities you won’t want to miss

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