Canadians hoping the Bank of Canada cuts interest rates soon should be careful what they wish for, experts warn, as lowering borrowing costs are likely to reignite the housing market, potentially exacerbating the country’s affordability crisis.

“If what we’re looking at is housing affordability, then… an interest-rate cut is merely going to fuel the market further still — and that’s going to be across all Canadian markets,” Moshe Lander, a senior economics lecturer at Concordia University, tells STOREYS.

Over the past two years, the central bank has embarked on a historic campaign of hikes to its overnight rate, which impacts borrowing costs, including mortgage payments. It increased the overnight, or key, interest rate, a total of 10 times since 2022, bringing it from 0.25% to where it stands today at 5% — the highest it’s been in more than 20 years. The rapid run-up in rates has, in turn, made it tougher than ever for Canadians to afford homes, according to a recent report from RBC.

The BoC’s goal was to get sky-high inflation — it had soared to a near 40-year high of 8.1% in June 2022 — back into the central bank’s target range of 1-3% by discouraging spending, which tends to drive up the price of things. With the latest reading of the Consumer Price Index, a leading inflation indicator, sitting at 2.8%, many experts predict the next move to be a cut, most likely at the scheduled announcement on June 5 (rather than tomorrow, April 10). However, Lander suspects that anticipation of a cut might be enough to begin boosting housing activity. Therefore, buyers who are worried about being priced out of the market should consider stomaching today’s more expensive mortgage payments to avoid tomorrow’s bidding wars.

Paul Kershaw, a policy professor in the UBC School of Population and Public Health, agrees that rate cuts will probably stoke demand for housing, accelerating price gains as more homebuyers bid on the market. “It is likely to be a factor that will drive up average home prices,” he tells STOREYS. “We contribute to the demand side of the equation by making credit cheaper again.”

Lower rates may help current borrowers, but the potential for large price gains amid renewed demand are cause for concern. “We need to acknowledge that even well before the pandemic — and definitely during the pandemic — [interest rates] were too low when it comes to thinking about their harmful impact on the housing market,” says Kershaw. He notes there could be knock-on effects for renters, too. In the past, when home prices soared, more would-be buyers were forced to remain tenants, which added to the rental shortage and drove up rents.

While higher interest rates may have temporarily contained home prices — which had long been lapping wage increases — the BoC can’t just focus on housing when making decisions. Its policy rate has to respond to the overall economy, Lander notes. “The Bank of Canada has to look at the broader macroeconomic picture, not each individual market when deciding what to do with interest rates,” says Lander, who expects the Bank of Canada to begin trimming rates in July, suggesting policymakers are going to be especially cautious. The potential for lower rates makes it crucial that different levels of government step up with more solutions to try and improve overall affordability, Lander and Kershaw note.

Supply Remains The Main Solution

Many experts agree that building more homes is crucial for restoring housing affordability, and policies that can accomplish this should be a priority, suggests Lander. “You always need to be focusing on the supply side in this market,” he continues. “The problem is if municipalities don’t take the housing problem seriously,” Lander adds.

Well, are they?

“There’s a lot of lip service that’s given,” he answers.

The challenge, he says, is it takes years of advanced planning and forecasting to set the right targets: “Municipalities need to be thinking 25 years out about what are the consequences of not taking action now? And what is going to be the cost of inaction later?”

Something like legalizing multiplex dwellings as of right — which BC is implementing province-wide this summer but which Ontario Premier Doug Ford recently struck down for Ontario, choosing to let municipalities decide on an ad-hoc basis — would be a step in the right direction. But Lander suggests it’s going to take a lot more from all levels of government.

Adding to suburban sprawl isn’t enough either, since developing sites outside the city centre requires massive infrastructure investments. Cities need to add more homes within their existing borders, including by tearing down medium- or high-density buildings for even more intensification. The trend has been playing out in Toronto recently, with some aging purpose-built rental buildings facing the wrecking ball as developers try to squeeze even more density out of the sites.

“We absolutely need more supply,” Kershaw agrees. “But if supply were the only factor, then Alberta should have higher home prices on average than BC and Ontario, because they have less supply per capita there than BC and Ontario, according to Scotiabank,” he says, arguing that demand-size measures are needed, too. One example could be by expanding on a national level something similar to BC’s additional school tax rate, where more tax is applied to the portion of a value of a home above a certain threshold. “It would be a bigger signal on the demand side than we have seen, generally speaking.”

Although a variety of policies are required to make a dent in Canada’s broader housing challenges, Lander acknowledges that lower rates will meaningfully benefit current borrowers if not those who later buy. “I anticipate that by the time the rate-cutting cycle is done, rates will fall maybe about one-and-a-half percentage points, so that’s pretty substantial when you’re talking about a 25-year mortgage,” he adds. “It’s not something to be sneezed at.”