The Bank of Canada officials have expressed their concerns ahead of announcing this month's interest rate cut, fearing that easing rates could overheat the housing market.

Interest Rate Cut Decision

During the monetary policy meeting on June 5, the six members of the Governing Council decided to lower the benchmark rate from 5.00% to 4.75%. This decision reflects increased confidence in inflation moving towards the 2% target, supported by four consecutive months of declines in the Bank's preferred measures of underlying inflation.

Risks of Housing Market Overheating

The members highlighted that rate cuts could lead to an overheating of the housing market, given the pent-up demand. Such overheating would drive up prices, potentially rekindling inflationary pressures and complicating the Bank's efforts to maintain stable economic growth.

Impact on Consumption and Economic Growth

The Bank of Canada estimates that about 80% of existing mortgages as of March 2022 will need to be renewed by the end of 2024. Renewing these mortgages at higher rates could reduce household spending, slow economic activity, and temper inflation more than expected.

Despite these concerns, the members acknowledged that consumer spending could rebound as consumer confidence recovers. However, persistent wage growth and low productivity could also lead to inflationary pressures.

Economic Forecasts

Michael Davenport, an economist at Oxford Economics, predicts that the shock of higher mortgage payments will impact households in the coming months, leading to a decline in consumption in the second and third quarters. This could contribute to a modest recession this year, with a potential drop in the key interest rate from 4.75% to 2.25% by the end of 2026.

Conclusion

The Bank of Canada's easing trajectory could be threatened if the economy avoids a slowdown, labor markets remain resilient, or housing prices rebound too quickly. The next Bank of Canada monetary policy meeting is scheduled for July 24.