Canada's Housing Bubble

Economist says Bank of Canada may be underestimating inflationary impact of red-hot resale market

Steve Ladurantaye Globe and Mail Dec. 14, 2009

Canada is likely inflating a housing bubble, Bank of America Merrill Lynch warned Monday in its 2010 investment outlook.

“We've got a long way to go before we could put a bubble label on this market,” economist Sheryl King said. “However, with mortgage rates at decades low – and even more attractive if home buyers choose the variable mortgage option which carries rates as low as 2 per cent – the seeds of a bubble are definitely in place.”
She said policy makers could underestimate the problem because of the way the Bank of Canada calculates inflation – overemphasizing new-home sales and ignoring the red-hot resale market in its consumer price index calculations.

“New-home prices can vary greatly from resales, and new homes are only 20 per cent of overall home transactions,” she said. “There is a real question of whether the CPI captures the full real estate asset story.”

New-home prices rose 0.3 per cent month-over-month in October and are up 1.1 per cent annualized in the third quarter, after 5 per cent declines in the first two quarters of the year. However, the Teranet 6-city home price index shows resale prices in the last three months are up 23 per cent on an annualized basis.

“With monetary policy in such stimulus overdrive there is a real risk that the market could become overheated and an asset bubble could form,” she said.