Sunday, March 28, 2010

Housing Market Rally Raises Alarm Bells - Bank of Canada expected to boost its policy rate by 100 basis points to 1.25% by year end

RBC reports that the overheated market is signaling alarm bells and the Bank
of Canada will increase rates by about 1 to 1.25% by year end to slow the
growth of a real estate bubble.

Housing Market Rally Raises Alarm Bells

The sharp recovery in Canada's housing market that began in January 2009 is
raising concerns that a bubble is forming. With sales running more than 60%
faster than a year earlier in the latter part of 2009 and early 2010,
worries about a bubble cannot be dismissed.

Our take is that significant demand was built up during the early days of
the recession because uncertainty saw buyers step back, and the volume of
sales plunged 36% on a year-over-year basis. With the recession in full
swing, the Bank of Canada lowered its policy rate to just 25 basis points
and housing market activity ramped back up.

In early 2010, another catalyst for sales activity was the rush to purchase
new homes prior to the Harmonized Sales Tax (HST), which will increase taxes
for Ontario and British Columbia, and becomes effective on July 1, 2010.
These two provinces accounted for about 60% of home sales activity in 2009.

The supply and demand fundamentals supported the strong housing market
performance. On the supply side of the equation, uncertainty saw sellers
hanging back with the supply of new listings falling well short of demand
during the recession.

Housing starts weakened also dampening available housing stock. In the near
term, housing market conditions are likely to remain strong reflecting
support by a brightening labour market and low mortgages rates. RBC's
affordability measure showed that, despite the run-up in prices late last
year, conditions remain better than in early 2008.

The market, however, is likely to start to slow mid-year as the HST boosts
costs and the Bank of Canada begins the process of normalizing interest

We expect the Bank to boost its policy rate by 100 basis points to 1.25% by
year end, which will translate into higher rates across the spectrum of
interest-rate related products

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