Kiyoko Fujimura
December 23, 2009

Mark Carney, governor of the central bank of Canada, has had his hands full lately.

His troubles began two summers ago, when he was trying to balance what was more important: the real estate bubble in the US threatening the balance of the global economy or the potential for rising food and oil prices to be inflationary. Carney knew that lowering interest rates in the economy would counter the possible economic slowdown initiated by the US real estate crash, but also might push inflation beyond the 2% target*.

What he wouldn’t give to go back to that conundrum.

With the stagnating economy of the past year, we’ve seen the Central Bank maintain record-low interest rates to bolster the economy, which was the prevailing course of action globally. But, despite the strong consensus, many are questioning whether the promise to maintain those interest rates until the summer was a mistake.

The reason? The potential for Canadian homeowners to fall victim to the same US-style real estate bubble that put us in this mess to begin with.

Carney doesn’t want to go down as Canada’s Alan Greenspan (who, if you could blame the global recession on one man, it would be this disgraced former head of the Federal Reserve). Variable rate mortgages rates are as low as 2%, and with the inevitable interest rate hikes in the coming years, the question is: “Can homeowners really afford it?” Also, there is an alarmingly high metric which compares the price of houses to the equivalent stream of rent payments.

These indicators are troublesome especially coupled with the fact that while the rest of the developed world seems to be suffering from devalued real estate, Canadian homeowners are benefiting from record-high house prices. Though this could be due to the prudence of our central bank, chartered banks and fiscal policy, it is difficult to believe that Canada’s financial trifecta is not only keeping housing prices stable, but actively driving them forward.

But are these symptoms being over-analyzed because housing bubbles seem to be “in” right now?

After all, we’ve had quite a shortage of supply in the past year as new homes were not keeping apace with demand. November has seen a slight easing in prices as supply begins to rebound (a 5% increase in new listings over October).

The bottom line remains: Will the increase in the cost of borrowing cripple growth in the market and send prices falling? If the market continues in the direction it was in October then, yes, but if November figures are setting the trend, Canadian homeowners likely have nothing nothing to worry about. However, in these tumultuous financial times, Carney can’t rest on November’s figures, the BOC must continue to monitor the possibility of a housing bubble and, if necessary, deal with it more effectively than our neighbours to the South.

*Lowering interest rates makes the cost of borrowing lower so it stimulates the economy, but when financing is cheap prices tend to increase causing inflation (which is essentially a tax on wealth). This is the fundamental way central banks conduct monetary policy.

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