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A leading economist with one of Canada’s biggest banks has flagged what he says would topple the Canadian housing market, while dishing out advice for how the Bank of Canada can steer clear of a crushing outcome.

“The ultimate risk to Canada’s housing market is not higher rates, but fast rising rates,” warns Benjamin Tal, CIBC’s deputy chief economist, in a recent note.

“Impotent” is how Tal describes all major central banks excluding China’s. Previous policy decisions on slashing interest rates have left these institutions with limited options, he argues.

“Interest rates are now about as low as they can go (in these markets) and the marginal effectiveness of taking them lower is diminishing,” says Tal.

Last year, the Bank of Canada cut the key interest rate twice leaving it at a historically low 0.5 per cent. (For more on how the key interest rate influences mortgage rates read a detailed explanation here.)

“Ultra-low interest rates mask a lot of bad things that will not be fully visible until rates rise,” says the CIBC economist. “We might have reached a point in which the cost of low rates exceeds their benefit,” notes Tal.

Low interest rates encourage borrowing. While they can boost housing markets by making mortgages — and subsequently homeownership — more affordable, with ramped up lending activity comes increased household debt, which hit record heights towards the end of 2015.

Earlier this year, Lawrence Schembri, the Bank of Canada’s deputy governor, warned this rising household debt makes the economy and financial system vulnerable to interest-rate shocks. In April, the Bank of Canada said two thirds of outstanding credit households owe came from residential mortgage debt.

“In Canada, the central bank continues to warn about the risk of debt accumulation and overvalued real estate markets, but at the same time, at this stage of the game, it is more comfortable cutting rates than raising them,” says Tal.

Raising interest rates, however, is something Tal recommends, and the sooner the better to avoid a shock later on.

“The longer rates stay abnormally low, the greater risk we develop an economy addicted to low rates, in which a modest but swift increase in rates can be recessionary,” he explains.

“Starting early and moving very slowly over the coming two-three years will buy insurance against the risk of being forced to raise rates quickly (eg. Greenspan in 2004)—a scenario that would bring Canadian housing to its knees,” Tal says.

Alan Greenspan, the US federal reserve’s chairman between 1987 and 2006, initiated 14 consecutive benchmark overnight lending rate hikes from June 2004 to January 2006, when he stepped down. The flurry of hikes followed several years of rock-bottom interest rates stateside.

Many blame Greenspan for the US housing bubble.

“Luckily, there is still time,” says Tal. “The earlier the bank starts hiking, the slower it can go.”

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