Hot housing market could trigger interest rate hikes, TD bank says

The possibility exists that the Bank of Canada might raise its key interest rate before inflation hits its preferred target should the housing market continue its red-hot performance, economists at Toronto-Dominion Bank said Tuesday.

"The Bank of Canada will likely be watching developments in Canadian real estate quite closely," said economists Craig Alexander and Grant Bishop. "If surging existing home sales do not cool, the bank may be inclined to respond."

The Bank of Canada -- in its effort to revive the economy and bring inflation to the two per cent level -- made a conditional pledge to keep its policy rate at a historic low of 0.25 per cent until June 2010. The historically low policy rate has drawn buyers into the housing market, as there is the belief that this will be as good as it gets in terms of borrowing costs.

The TD prediction comes hours after Australia's central bank surprised markets and raised its benchmark rate by 25 basis points -- a sign it believes the economy is in recovery mode.

While raising rates might not be his preferred option, the TD report said Mark Carney, Bank of Canada governor, has hinted in recent remarks that he is prepared to "lean" against so-called prevailing wisdom when undertaking future decisions regarding monetary policy. That could mean, they suggest, raising rates even though inflation is not hovering near the central bank's two per cent target.

"The persistence of extremely low mortgage rates might induce more buyers into the market and speculation could take on a greater influence," Alexander and Bishop said. "In the wake of the recent financial turmoil and deep economic downturn arising from the bursting of the U.S. real estate bubble . . . many central bankers now believe that monetary policy needs to 'lean' against the development of asset price excesses by running a tighter monetary policy."

Canadian housing sales have surged in recent months. The Canadian Real Estate Association estimate of national homes sales was up 18.5 per cent year-over-year in August, and the average home price was reported to have increased 11.3 per cent over that time.

The TD economists said the real estate market is likely to moderate and home-price growth will not become excessive, as pent-up demand gets filled. However, they said there is a "material risk" real estate could continue its red-hot pace.

(prepared by Paul Viera/Vancouver Sun)