Anticipated interest rate hikes from the Bank of Canada could lead to a "toppling" of the housing market, a new report from Capital Economics warns.

In a note published Wednesday, Capital Economics' Senior Canada Economist Stephen Brown cautioned that the 2.5% interest rate expected to be implemented next year poses a "key risk to housing." This prediction comes after the Bank of Canada raised its rate to 0.5% after sitting at a historically low 0.25% since March 2020. Several more raises are expected to come throughout the year.

READ: Borrowers Can Expect At Least Four More Interest Rate Hikes This Year

"We recently set out how, due to the much larger share of variable rate mortgages than before the pandemic, the Bank of Canada would need to raise its policy rate to 2.5% to achieve the same average mortgage rate on new borrowing as when the policy rate peaked at 1.75% in late-2018," Brown wrote.

"Following the sharp move in the past two weeks, that is exactly what markets are now pricing in for next year. The question, therefore, is can the housing market withstand a return to pre-pandemic mortgage rates, even though prices have risen by more than 50% in the interim? The answer is a firm 'no.'" 

Capital Economics is forecasting that the policy rate will peak at 2.0% and that home price inflation will slow close to zero in 2023. But any higher rate increase, Brown notes, could "trigger house price declines." With home prices having risen so quickly during the pandemic, breaking records month after month, Brown says that there's a risk that any initial decline in prices could trigger a downward spiral of lower and lower home price expectations, which is not necessarily something the Bank of Canada wants to prevent.

"Admittedly, we shouldn’t assume that the Bank wants to avoid house price declines at any cost," Brown says. "House prices are a key driver of shelter inflation, so moderate declines would help to get consumer price inflation under control without seriously jeopardising the economy."

Brown's report comes just days after the Teranet-National Bank House Price Index revealed that Canadian home prices have risen for the 20th month in a row, up 17.7% year-over-year. Major cities across the country, including Toronto, Victoria, Hamilton, and Halifax, have each seen annual home price growth over 20%.