Interest rate hikes could slash Canadian home prices by 10%, claims a note to investors from Capital Economics.

In a missive to clients on Monday, Stephen Brown, Senior Canada Economist at Capital Economics, wrote that home prices are usually the first domino to fall when interest rates rise and he expects things will be no different this time. Moreover, because home sales have begun falling, especially in Toronto, Montreal and Vancouver, Brown wonders not whether or not home prices will decrease but by how much.

READ: Early Data Shows GTA Housing Prices on "Rapid Decline" in April

Fixed mortgages rates have also been increasing for the last few months as a prolusion to rate hikes, and lately variable rates, which comprise over 50% of new mortgage originations, are rising in tandem with the prime rate.

Brown anticipates that home sales will halve from their first quarter peak, which would be around a 25% fewer than the average in 2019, because prices are so elevated that they have become radically divorced from market fundamentals. In the absence of red-hot sales, there’s nowhere for prices to go but down, Brown wrote.

However, a 10% reduction in value would affect investment in housing, which could soften economic growth but not necessarily GDP growth, and a decline of more than 10% would trigger a recession, Brown surmised, adding that the Bank of Canada is probably underestimating how crucial interest rates are to real estate investors’ decision making and that it is, therefore, too aggressive in its hiking campaign. He anticipates rates will remain sideways once the policy rate hits 2.5%.

However, if housing prices fall too precipitously, Brown believes the central bank would loosen its policy, although it would be highly unlikely that it drops its overnight rate to 25 basis points.

READ: Macklem Says Bank of Canada Will Consider Half-Point Hike in June

Although variable rate mortgages are now in the majority, they come with fixed payment amounts, which should help avert forced sales, Brown wrote.

Last month, home sales in the Greater Toronto Area declined by 27% from March, according to Toronto Regional Real Estate Board statistics, while RBC reported that sales in Vancouver declined by 22.3%. Montreal experienced a small sales decline of 2% month over month in April.

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