A Cautious Market: How Economic Factors Challenge the Effectiveness of Rate Cuts for the Real Estate Sector
October 4, 2024
By Allwyn Dsouza, Senior Analyst, Research and Insights, REIC/ICI
By Allwyn Dsouza, Senior Analyst, Research and Insights, REIC/ICI
The Bank of Canada's recent rate cuts have generated considerable excitement, particularly within the real estate sector. However, despite three consecutive cuts, there has been no meaningful recovery in the housing market. Key challenges such as rising unemployment, sluggish sales, and elevated household debt are undermining the affordability gains typically associated with lower interest rates. This outcome aligns with our June forecast where we cautioned that while rate cuts were widely anticipated, they would not be enough to address the deep structural issues within the real estate market. Solving these issues requires more than just monetary policy adjustments; broader systemic reforms are necessary to reignite housing market stability.
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The Impact of Rate Cuts on the Housing Market: The Bank of Canada has initiated a rate-cutting cycle reducing the policy rate to 4.25%. After three consecutive cuts aimed at stimulating borrowing by lowering mortgage rates and theoretically improving housing affordability, the real estate market’s response has been notably subdued.
According to recent CREA reports [1], home sales in Canada rose by a mere 1.3% in August 2024 despite the rate cuts, highlighting sluggish buyer activity. In a typical market, such a reduction in interest rates would trigger a surge in demand, similar to the post-pandemic boom when the BoC slashed rates to near zero. Today, however, the market faces a vastly different reality with high household debt levels and cautious buyer sentiment dampening any significant recovery. Since the beginning of the rate-cutting cycle, home prices have fallen by nearly 8%, reflecting the broader economic challenges that are counteracting the effects of lower borrowing costs.
According to recent CREA reports [1], home sales in Canada rose by a mere 1.3% in August 2024 despite the rate cuts, highlighting sluggish buyer activity. In a typical market, such a reduction in interest rates would trigger a surge in demand, similar to the post-pandemic boom when the BoC slashed rates to near zero. Today, however, the market faces a vastly different reality with high household debt levels and cautious buyer sentiment dampening any significant recovery. Since the beginning of the rate-cutting cycle, home prices have fallen by nearly 8%, reflecting the broader economic challenges that are counteracting the effects of lower borrowing costs.
Figure 1.0
Source: CREA
Figure 2.0
Source: CREA
* non-seasonally adjusted
* non-seasonally adjusted
Historical Lessons: Why Lower Rates May Not Be Enough
Figure 3.0
Source: Bank of Canada, Statcan, Table 18-10-0205-01 New housing price index, monthly
A comparison of previous rate-cutting cycles provides crucial context for the current housing market situation. Apart from the rapid rate cuts during the COVID-19 pandemic, history shows that similar moves have often failed to revive the housing market during broader economic downturns. During major crises like the oil price shock of the early 1980s, the dotcom bust of the early 1990s, and the global financial crisis of 2008, the Bank of Canada (BoC) significantly cut rates, yet home prices continued to decline, transitioning the market from a seller’s market to a buyer’s market. This historical trend suggests that rate cuts alone are insufficient to stimulate a housing recovery in periods of economic weakness. A report by Real Estate Magazine puts this in perspective [2].
These past examples demonstrate that even with significant interest rate cuts, housing prices tend to fall in tandem with broader economic weakness including rising unemployment and inflation.
As we face similar challenges today—rising unemployment and strained household budgets—it’s clear that rate cuts alone may not be enough to spur housing demand. Moreover, most Canadian mortgages are fixed rate with many locked in during the pandemic lows. When these mortgages come up for renewal, the new rates, despite recent cuts, are likely to be much higher putting further strain on homeowners. Even with additional rate cuts expected later this year, the cumulative effect of economic deterioration and price declines is likely to keep potential buyers on the sidelines.
The Unemployment Factor: A Critical Counterbalance
Rising unemployment is a critical factor undermining the Bank of Canada’s efforts to stimulate the housing market. As unemployment climbs and job vacancies decline, fewer Canadians feel financially secure enough to take on major financial commitments such as purchasing a home.
- 1981-1983 Oil Price Inflation: The BoC rate peaked at 20.78% in August 1981, before falling to 9.26% by July 1983. Despite this drastic reduction, the home price index dropped by 14%, and inflation surged by 17%. In Vancouver, home prices plummeted by nearly 40% from early 1981 to mid-1982.
- 1990 Dotcom Bust: From Q2 1990 to Q1 1994, the BoC slashed rates from 13.5% to 3.6%. However, home prices still fell by 8% and inflation rose by 10%. The Greater Toronto Area (GTA) saw a 28% price drop between April 1989 and August 1993.
- 1995-1996: The BoC rate declined from 8.2% in March 1995 to 3% in November 1996. Even with this cut, home prices dropped by 4.5%, and inflation continued to rise. For instance, Vancouver saw a 17% drop in home prices between 1994 and 1998.
- 2007-2008 Global Financial Crisis: During this period, from Q2 2008 to Q1 2009, home prices declined by 9%, even as the BoC rate fell from 4.25% to 0.25%. Although prices rebounded quickly in 2009, this was due to an extraordinary level of government intervention and stimulus.
These past examples demonstrate that even with significant interest rate cuts, housing prices tend to fall in tandem with broader economic weakness including rising unemployment and inflation.
As we face similar challenges today—rising unemployment and strained household budgets—it’s clear that rate cuts alone may not be enough to spur housing demand. Moreover, most Canadian mortgages are fixed rate with many locked in during the pandemic lows. When these mortgages come up for renewal, the new rates, despite recent cuts, are likely to be much higher putting further strain on homeowners. Even with additional rate cuts expected later this year, the cumulative effect of economic deterioration and price declines is likely to keep potential buyers on the sidelines.
The Unemployment Factor: A Critical Counterbalance
Rising unemployment is a critical factor undermining the Bank of Canada’s efforts to stimulate the housing market. As unemployment climbs and job vacancies decline, fewer Canadians feel financially secure enough to take on major financial commitments such as purchasing a home.
Figure 4.0
Source: Statistics Canada. Table 14-10-0287-01 Labour force characteristics, monthly, seasonally adjusted and trend-cycle, last 5 months
A weakening labour market erodes consumer confidence causing potential homebuyers to hesitate before making large financial decisions. Furthermore, those who face job loss or reduced income may be forced to sell their homes which increases housing supply and puts downward pressure on prices. This creates a paradox: while rate cuts theoretically improve affordability, they do little to address the more pressing issue of job insecurity, which ultimately stifles demand in the housing market.
The employment rate—the proportion of the population aged 15 and older who are employed—fell by 0.1 percentage points to 60.8% in August 2024, marking the fourth consecutive monthly decline. Simultaneously, the unemployment rate rose by 0.2 percentage points to 6.6%, the highest rate since 2017 excluding the COVID-19 period. [3]
This weakening labour market is particularly problematic for real estate as it suggests that sales may continue to be restrained well into 2025 even with favorable interest rates. Without broader economic improvements and job security, the housing market is unlikely to see significant recovery despite rate cuts.
Supply and Demand Imbalances
Another significant factor muting the impact of the BoC’s rate cuts is the persistent supply-demand imbalance in the housing market. The sales-to-new listings ratio has remained stagnant, at around 53%, with new listings rising by 1.1% month-over-month. This indicates that although more homes are coming to market, buyers are not responding with urgency.
The number of properties listed for sale has surged nearly 19% compared to a year ago, which reflects a "wait-and-see" approach from potential buyers. In larger markets like Toronto and Vancouver, many 2021-22 buyers are now sitting on negative equity and experiencing cashflow issues with rental properties. This is exacerbated by relatively high borrowing costs which continue to strain affordability despite the BoC's rate cuts. Although variable mortgage rates are becoming more attractive, the stress test qualification remains a substantial barrier for buyers. For there to be significant buying activity, interest rates will need to drop even further from current levels.
The employment rate—the proportion of the population aged 15 and older who are employed—fell by 0.1 percentage points to 60.8% in August 2024, marking the fourth consecutive monthly decline. Simultaneously, the unemployment rate rose by 0.2 percentage points to 6.6%, the highest rate since 2017 excluding the COVID-19 period. [3]
This weakening labour market is particularly problematic for real estate as it suggests that sales may continue to be restrained well into 2025 even with favorable interest rates. Without broader economic improvements and job security, the housing market is unlikely to see significant recovery despite rate cuts.
Supply and Demand Imbalances
Another significant factor muting the impact of the BoC’s rate cuts is the persistent supply-demand imbalance in the housing market. The sales-to-new listings ratio has remained stagnant, at around 53%, with new listings rising by 1.1% month-over-month. This indicates that although more homes are coming to market, buyers are not responding with urgency.
The number of properties listed for sale has surged nearly 19% compared to a year ago, which reflects a "wait-and-see" approach from potential buyers. In larger markets like Toronto and Vancouver, many 2021-22 buyers are now sitting on negative equity and experiencing cashflow issues with rental properties. This is exacerbated by relatively high borrowing costs which continue to strain affordability despite the BoC's rate cuts. Although variable mortgage rates are becoming more attractive, the stress test qualification remains a substantial barrier for buyers. For there to be significant buying activity, interest rates will need to drop even further from current levels.
Figure 5.0
Source: CREA
Figure 6.0
Source: CREA
Table 1.0 Posted Canadian Mortgage Rates
The Risk of Inflation and Future BoC Decisions
The Bank of Canada’s rate-cutting trajectory may face significant challenges if inflation resurges, particularly as global central banks coordinate easing measures and China rolls out major stimulus efforts. Additionally, if real estate markets respond strongly to these rate cuts, it could stoke shelter inflation, a key component of CPI inflation, which accounts for nearly 30%. This presents a risk: while rate cuts are designed to stimulate economic growth, they could also reignite inflationary pressures—especially in the housing market—undermining the very benefits these cuts are meant to achieve.
The Bank of Canada’s rate-cutting trajectory may face significant challenges if inflation resurges, particularly as global central banks coordinate easing measures and China rolls out major stimulus efforts. Additionally, if real estate markets respond strongly to these rate cuts, it could stoke shelter inflation, a key component of CPI inflation, which accounts for nearly 30%. This presents a risk: while rate cuts are designed to stimulate economic growth, they could also reignite inflationary pressures—especially in the housing market—undermining the very benefits these cuts are meant to achieve.
Figure 7.0
Source: Statistics Canada. Table 18-10-0004-01 Consumer Price Index, monthly, not seasonally adjusted
An additional risk is that falling interest rates could stoke inflation, forcing the BoC to reconsider its rate-cutting trajectory. A strong rebound in the housing market could drive up house prices and reignite inflationary pressures. Although inflation has cooled to 2%, largely due to declines in energy and gasoline prices, external factors, such as rising geopolitical tensions in the Middle East, could disrupt global oil supplies and reignite inflation.
Should inflation accelerate, the BoC may be forced to pause or reverse its rate cuts, further complicating the real estate market’s recovery. Higher inflation would erode the affordability gains from lower mortgage rates, neutralizing any potential boost to housing demand from the BoC's policy moves. Ultimately, while rate cuts are aimed at economic relief, they also carry the risk of intensifying inflation, particularly in the volatile real estate sector.
Policy Interventions and Market Adaptations
Despite these challenges, policy interventions, such as increasing the mortgage insurance cap to $1.5 million, could facilitate more buyers entering the market, especially in expensive urban centers. Extending mortgage amortization periods beyond 25 years could also help reduce monthly payments, making homeownership more attainable for some buyers.
However, these measures are unlikely to serve as a comprehensive solution. They risk distorting segments of the market, particularly the single-family home sector, by attracting buyers into a price range that may not have been affordable otherwise. This could ultimately lead to higher prices putting homeownership out of reach for even more potential buyers.
Moreover, favourable policies alone cannot counteract the broader economic conditions affecting the market, such as rising unemployment and high household debt levels. Buyers are likely to remain cautious until there is clearer guidance from the BoC regarding future rate decisions and a better understanding of the overall trajectory of the Canadian economy.
Conclusion: A Slow and Uneven Recovery
In conclusion, while the Bank of Canada’s rate cuts aim to lower borrowing costs and theoretically stimulate the housing market, several factors hinder a robust recovery. Rising unemployment, cautious buyer sentiment, and the looming mortgage renewal cliff present significant challenges that could negate the advantages of lower rates. Historical patterns indicate that rate cuts alone often fail to rejuvenate the housing market, particularly during times of economic uncertainty.
Moreover, the very policies designed to stimulate demand could exacerbate underlying issues such as inflation, prompting the BoC to reevaluate its approach. Although targeted policy interventions—like raising the mortgage insurance cap or extending mortgage amortization periods—offer potential avenues for improvement, the overall outlook for Canada’s real estate market remains subdued. Any recovery is likely to be slow and uneven, reflecting the complexities of the current economic landscape.
The Real Estate Institute of Canada (REIC) is dedicated to enhancing professionalism and ethical standards within the real estate industry, especially in times of economic uncertainty. In light of recent challenges, including rising unemployment and the impact of interest rate cuts on housing affordability, REIC empowers its members through comprehensive educational programs to be competent advisors. By fostering a culture of ethical leadership and providing innovative solutions, REIC plays a critical role in addressing pressing housing issues, ensuring that real estate practitioners are equipped to navigate and adapt to the evolving market landscape.
Should inflation accelerate, the BoC may be forced to pause or reverse its rate cuts, further complicating the real estate market’s recovery. Higher inflation would erode the affordability gains from lower mortgage rates, neutralizing any potential boost to housing demand from the BoC's policy moves. Ultimately, while rate cuts are aimed at economic relief, they also carry the risk of intensifying inflation, particularly in the volatile real estate sector.
Policy Interventions and Market Adaptations
Despite these challenges, policy interventions, such as increasing the mortgage insurance cap to $1.5 million, could facilitate more buyers entering the market, especially in expensive urban centers. Extending mortgage amortization periods beyond 25 years could also help reduce monthly payments, making homeownership more attainable for some buyers.
However, these measures are unlikely to serve as a comprehensive solution. They risk distorting segments of the market, particularly the single-family home sector, by attracting buyers into a price range that may not have been affordable otherwise. This could ultimately lead to higher prices putting homeownership out of reach for even more potential buyers.
Moreover, favourable policies alone cannot counteract the broader economic conditions affecting the market, such as rising unemployment and high household debt levels. Buyers are likely to remain cautious until there is clearer guidance from the BoC regarding future rate decisions and a better understanding of the overall trajectory of the Canadian economy.
Conclusion: A Slow and Uneven Recovery
In conclusion, while the Bank of Canada’s rate cuts aim to lower borrowing costs and theoretically stimulate the housing market, several factors hinder a robust recovery. Rising unemployment, cautious buyer sentiment, and the looming mortgage renewal cliff present significant challenges that could negate the advantages of lower rates. Historical patterns indicate that rate cuts alone often fail to rejuvenate the housing market, particularly during times of economic uncertainty.
Moreover, the very policies designed to stimulate demand could exacerbate underlying issues such as inflation, prompting the BoC to reevaluate its approach. Although targeted policy interventions—like raising the mortgage insurance cap or extending mortgage amortization periods—offer potential avenues for improvement, the overall outlook for Canada’s real estate market remains subdued. Any recovery is likely to be slow and uneven, reflecting the complexities of the current economic landscape.
The Real Estate Institute of Canada (REIC) is dedicated to enhancing professionalism and ethical standards within the real estate industry, especially in times of economic uncertainty. In light of recent challenges, including rising unemployment and the impact of interest rate cuts on housing affordability, REIC empowers its members through comprehensive educational programs to be competent advisors. By fostering a culture of ethical leadership and providing innovative solutions, REIC plays a critical role in addressing pressing housing issues, ensuring that real estate practitioners are equipped to navigate and adapt to the evolving market landscape.
[1] https://stats.crea.ca/en-CA/
[2] https://realestatemagazine.ca/a-historical-look-at-the-bank-of-canadas-rate-cuts-will-they-boost-the-housing-market/
[3] https://www150.statcan.gc.ca/n1/daily-quotidien/240906/dq240906a-eng.htm
[2] https://realestatemagazine.ca/a-historical-look-at-the-bank-of-canadas-rate-cuts-will-they-boost-the-housing-market/
[3] https://www150.statcan.gc.ca/n1/daily-quotidien/240906/dq240906a-eng.htm
Allwyn Dsouza is REIC’s Senior Analyst, Market Research and Insights. He can be reached at [email protected]. Media enquiries can be directed to [email protected]