Canadian real estate prices are rising due to demand, but how much of it is excess? That’s a question MET addressed in his latest research paper, looking at the volumes of home sales. The bank estimates that surplus demand, driven by the central bank, is now 6 points of gross domestic product (GDP). Remember, that’s just the redundant question. The stimulus has driven housing costs significantly higher, with the bank seeing no relief until the central bank breaks the pauses.

Canada’s “excess” housing demand is now 6% of GDP

Canada went all-in on housing to the point where only surplus sales are now the size of a small country’s economy. The value of MLS home sales reached $500 billion year-on-year in October. Using data from the past 15 years to establish a trend, BMO estimates that there is currently an excess demand of $150 billion per year.

It’s as big as it sounds – that’s an astronomical amount of excess demand. The extra home sales above and beyond normal are nearly half of Toronto’s GDP. “…a cool 6% of GDP on top of what would otherwise be considered normal,” said Robert Kavcic, senior economist at BMO.

The value of Canadian existing home sales versus the trend

Source: MET.

Adding: “…in fact, the amount of ‘excess’ dollar volume on the market now is almost equal to a very good year overall over the 2010-2015 period.”

Excessive demand for Canadian housing drives prices up

Excessive demand plays an important role in driving up house prices. It is often said that there is a low housing stock. However, the stock has shown stable growth in recent years.

The inventory is just having a hard time keeping up with the recent increased demand. It’s also not a new normal for demand, despite some experts’ assumption. This has been largely stimulated by policy makers seeking to create demand.

The Bank of Canada’s Role in Stimulating Excessive Demand

The Bank of Canada (BoC) has one main goal and that is to keep inflation low and stable. It does this by ensuring that credit growth is sufficient to meet its target rate of 2%. The main way it manages inflation is by influencing the cost of debt with the overnight interest rate.

When inflation is low, central banks generally lower interest rates to encourage borrowing. The goal is to make credit so cheap that people are encouraged to borrow to buy large goods, such as houses. By doing so, they hope to create enough demand to push inflation toward target. Stimulated demand is often brought forward from people who can now borrow more money.

When inflation is too high and lending grows too fast, the BoC raises interest rates. By doing so, they make credit more expensive in an effort to dampen the desire to borrow. This reduces buyer demand and eases price pressures, pushing inflation down. Most demand doesn’t disappear permanently, but slows down as they save more to buy.

In the current environment, the stimulus of a rate cut is not enough demand. In addition to the cut, the central bank has also used quantitative easing (QE). This is when it buys government bonds with the aim of lowering interest rates. By doing so, they also lower the cost of borrowing debt. It has a similar function to interest rate cuts, where they try to drive up inflation.

Canada is addicted to cheap economic growth

What happens if a central bank ignores its data and starts… chasing political goals? The BoC didn’t wait for data when the pandemic started, but guessed how much was needed. They cut interest rates and bought billions in mortgage bonds before the impact was felt.

If you think predicting a home crash is foolish, you’ll love this. The BoC didn’t just predict a housing crash – it predicted one and then used billions in capital to fix it before it happened. They were wrong about the crash, but only because they created excessive demand and then some.

They should be trying to correct an overstimulated economy, right? QE only ended two weeks ago and overnight interest rates are still incredibly low. The last time the economy (both GDP and unemployment) was at this level in 2017, they started raising rates. For some strange reason they don’t really like that. At the time, this data point was so strong that a bucket of cold water had to be thrown on it. Fast forward to the same data with record inflation and the BoC thinks things are looking disastrous.

BMO seems to agree with the assessment that these mechanics appear to have been abused. “We’ve said it before and we’ll say it again. This is only going to cool down if the BoC says so…” the research note concluded.