Miniature House on A Financial Graph

Canada’s housing market is more vulnerable to the risk of further monetary tightening than markets currently expect, DBRS Morningstar says in a new report.

Yesterday, the Bank of Canada officially paused its interest rate tightening cycle, keeping its key policy rate unchanged after a succession of rate hikes. However, the central bank also signalled it’s not necessarily done raising rates, and that future policy decisions remain data-dependent.

In a new report, DBRS explores the possibility that monetary tightening in Canada, the U.S. and the U.K. could be more aggressive over the next couple of years, warning that could prompt “severe” corrections in housing prices.

While it’s currently expected that the central banks in each of these markets will soon bring an end to rate tightening, if conditions instead push policy-makers to keep raising rates beyond mid-2023, and hold those rates higher for longer than expected, this would weigh on both investment and consumer confidence — ultimately hitting housing markets too, DBRS said.

“A scenario of higher interest rates would clearly pose challenges to all three economies, increasing unemployment and weakening corporate and household balance sheets,” it said.

“In such an adverse scenario, we project that the three economies would experience a recession this year with a slow recovery starting in mid-2024,” it added.

For Canada, the report said that in this scenario GDP growth could decline by 0.5 percentage points (ppts) this year, dropping by another 2.5 ppts in 2024, with unemployment rising by another 1.2 ppts than currently expected.

It also envisions a “significant” correction in housing prices in Canada this year if rates head higher than expected.

“This reflects in part the correction already underway in Canada, combined with the overall condition of household balance sheets,” it said, whild also noting that the effects of strong immigration and limited housing supply could mitigate the downside momentum.

However, even in this adverse scenario, DBRS said housing prices would remain “slightly above pre-pandemic levels.”

The report said DBRS’ modelling suggests that this severe downturn scenario “would at worst only undo the significant appreciation in the housing market since 2020.”