Philip CrossThe legacy of the surprise interest rate cut early in 2015 is likely to be heightened instability in the housing market and the need to rely on higher interest rates now to rein in what might soon again become Canada’s runaway housing markets, writes Philip Cross.

By Philip Cross, Aug. 17, 2017

Stephen Poloz, the governor of the Bank of Canada, justified the belated move to begin raising interest rates last month by saying that lower rates “have done their job.” That rationale is hard to understand coming from Poloz, who took office with the incalculable advantage of not being the preening Mark Carney. The Bank of Canada under Poloz has been wringing its hands for years about why neither manufactured exports or business investment had responded to the lower dollar, which was the intended purpose of its surprise January 2015 interest rate cut. At the same time, it also downplayed the roles played by lower interest rates and a lower dollar in inflating housing prices in Canada’s two largest housing markets, Vancouver and Toronto.

All that Toronto housing froth has only obscured worrying signs of Ontario’s seriously eroding economic base. Statistics Canada’s recent release of Ontario’s GDP data for the first quarter reinforces how dependent that province has become on the housing boom to drive its growth. Housing accounted for a jaw-dropping 37.1 per cent of Ontario’s income growth in the past year while also swelling government coffers with various fees on real estate transactions. Meanwhile, both exports and business investment continue to drop. But even with the real estate frenzy, in the absence of improved fundamentals, Ontario’s 1.1-per-cent year-over-year employment growth lagged far behind B.C.’s (at 4.4 per cent), Quebec (3.0 per cent) and even that of beleaguered Alberta (2.2 per cent).

Exports and investment

That exports and investment remain moribund did not stop the Bank of Canada last month from unfurling its “Mission Accomplished” banner, declaring victory for its low-dollar strategy and proceeding to raise interest rates. This victory lap may prove as premature as it was when former president George W. Bush tried it in 2003, famously misjudging America’s progress in Iraq. It is more likely that the bank reversed course and raised rates because of warnings from international organizations such as the OECD and the Bank for International Settlements that housing activity in Toronto and Vancouver was reaching unsustainable levels. Just last week, the Canadian Mortgage Housing Corp. warned of “strong evidence of problematic conditions” in Toronto and Vancouver’s housing markets.

Meanwhile, the OECD noted earlier this year that recent measures taken to cool the housing market in Toronto and Vancouver, such as foreign-buyers’ taxes, would provide temporary relief, as seems to be occurring. It added, however, that “speculation-fuelled price increases may resume” once the one-time impact of these measures passes. The OECD had warned earlier that history shows that “a rapid rise of house prices can be a precursor of an economic downturn” and that a disorderly decline in Toronto and Vancouver home prices would weaken income and wealth and “even threaten financial stability.”

We don’t know all of the forces driving the sudden surge in housing, although its coincidence with the January 2015 interest rate cut is a good starting point. Analysts have been heralding the new database being put together by Statistics Canada that is supposed to eventually track the various variables at play in the housing market. Except, that is, for buyers’ expectations — the most important factor when trying to evaluate if the housing market has become a bubble.


Robert Shiller of Yale University won a Nobel Prize in economics for demonstrating the importance of monitoring expectations while correctly diagnosing both the bubbles in stock market prices in 2000 and in U.S. housing prices in 2007 before they burst. Shiller understood it is the expectations of buyers, not their personal characteristics, that drive speculative bubbles. Buying reaches frenzied levels when people think prices are going to keep rising rapidly for the foreseeable future, the illusory promise of guaranteed, risk-free investment returns proving irresistible to many people and governments. Those kinds of data come from specially designed surveys, as in the Case-Shiller U.S. house price index, published monthly, not from massive databases on the demographics of buyers or the dwellings they purchase that Statcan has said it will be compiling.

The short-term outlook for the Canadian economy is likely to be determined by the unwinding of the excesses in the Toronto and Vancouver housing markets, now that the worst of the cuts in the oil patch are (at least temporarily) over. Despite Poloz’s sanguine outlook, removing the prop of housing from Ontario and B.C.’s growth will be a major drag on growth, especially in the absence of a pick-up in exports and business investment.

It’s clear that Canada is still missing improvement in the fundamentals of growth. That housing-related bump to incomes that occurred in the first half of this year of over three per cent is not being carried forward in anyone’s forecast for 2018, which is universally seen as returning us to the desultory rate of two per cent, to which we have so glumly become accustomed. Far from improving Canada’s economic growth fundamentals, the legacy of the surprise interest rate cut early in 2015 is likely to be heightened instability in the housing market and the need to rely on higher interest rates now to rein in what might soon again become Canada’s runaway housing markets, regardless of how that strategy drives up our dollar and makes exporters lives even harder.

Philip Cross is a Munk Senior Fellow at the Macdonald-Laurier Institute

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