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A Rate Cut Cuts Both Ways

If you believe financial traders who bet on interest rates, the chance of the Bank of Canada lowering rates this Wednesday is almost a coin flip. If the Bank does bring down rates, it could goose the housing market even more.

As most of us intuitively realize, there’s an inverse relationship between interest rates and property prices. According to TD’s research, for example, a 50 bps reduction in the 5-year mortgage rate can lead to as much as a 15% increase in home sales nationally. That’s top of mind for policy-makers who are bombarded by headlines about how housing markets are “clearly detached from reality.”

Unfortunately, the Bank of Canada can’t tailor rate cuts by region. It can’t leave Toronto mortgage rates and Vancouver mortgage rates as-is while cutting them everywhere else. That’s why, if the Bank of Canada does stimulate the economy again by lowering rates, there’s a very real chance that the Department of Finance could act again to decelerate home prices.

The DoF has been looking at the possibility of raising down payments for a while, but credible sources say they could get more serious about it if the Bank of Canada were to ease again. Raising the minimum down payment is the most direct leverage policy-makers have at their disposal to keep our red-hot markets from boiling over.

If Poloz takes rates lower either this week or on September 9, our bet is that the Department of Finance takes some action in the months that follow. It could do it behind the scenes or it could announce a policy change like raising the minimum down payment to between 7% and 10%. Such a move would have immediate impact. According to a Maritz poll, 22% of buyers say they would not have been able to afford a down payment if the minimum required equity was 10% instead of 5%. Keep in mind that almost 70% of CMHC’s transactionally insured mortgages in Q1 had down payments less than 10%.

Such a policy change would take a sizable minority of buyers out of the market, outweighing any affordability improvement of lower rates. So this Wednesday’s rate meeting could get very interesting indeed.