Canada just started lifting rates but a property bubble bursting could derail everything

Vancouver. Photo: iStock

The Bank of Canada showed that it’s one central bank turning hawkish sentiment into action, when it raised interest rates by 0.25% on Wednesday.

Canada’s benchmark cash rate is now 0.75% — still low by historical standards, although the market is forecasting more rate hikes in the near future.

That’s mainly because the BoC accompanied its rate increase with a policy statement that was considered more hawkish.

The move sent the Canadian dollar to a 12-month high against the USD, and the CAD is now holding steady above US78 cents.

The bank revised its growth forecast upwards and said it expects inflation to rise into 2018, with production increases leading to a pickup in exports.

While analysts from Goldman Sachs predicted that the BoC would stay on hold this week and raise rates in October, the chance of an October rate hike in addition to the July increase is now seen by the market as more probable than not.

However, not all analysts agree. In fact, the team at Capital Economics (with one eye firmly on Canada’s housing market) forecast that the BoC will actually reverse its latest rate increase.

“As it happens, we think that the Bank of Canada may end up reversing Wednesday’s rate hike, perhaps as soon as Q1 next year, because we anticipate that the bubble in Canada’s residential property market will burst,” Capital Economics said.

Like Australia, Canada’s level of household debt exceeds the country’s GDP. Research from Morgan Stanley this month showed that Canada’s household debt to GDP ratio is 101% (Australia’s ratio is 123.1%).

As part of their analysis, Capital Economics included a chart which shows that central banks in developed markets have commonly raised rates since the GFC, only to subsequently reduce them:

Thomson Reuters, Capital Economics

Capital Economics said that while the market interpreted the BoC’s statement is being more bullish, they noted that Governor Stephen Poloz did offer some notes of caution.

Poloz said that while labour market capacity is tightening with strong employment growth, it so far hasn’t led to an increase in inflation. It’s a theme that’s also been evident in the economic data of both Australia and the US as well.

“If inflation remains subdued or falls further in the coming years, any rate hikes should prove to be very small,” Capital Economics said.

Although Capital Economics predicts that the BoC will reverse course, they are still forecasting a slow and steady tightening of monetary policy by global central banks.

“We expect the next hikes to be in the UK and Sweden in the second quarter of 2018. They are likely to be followed by Australia, the euro-zone, Denmark, New Zealand and Switzerland in 2019.”