By slashing its key interest rate for the second time in less than a year, the Bank of Canada acknowledged it risks fanning the flames of household debt. But it said it expected the trade-off of stronger economic growth would help the country avoid a housing correction.

“Of particular note are the vulnerabilities associated with household debt and rising housing prices. And we must acknowledge that today’s action could exacerbate these vulnerabilities,” Governor Stephen Poloz told reporters after the central bank cut its benchmark overnight lending rate by 25 basis points to 0.5 per cent.

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However, weakening economic conditions in the wake of lower oil prices outstripped the risks from rising household debt. If left unaddressed, Mr. Poloz said, the economic shock could eventually prove to be the “trigger” that sparked a housing correction.

Industry observers said the rate cut is unlikely to translate into dramatically cheaper mortgage rates, which are already sitting near record lows. Toronto-Dominion Bank announced Wednesday that it was lowering its prime rate by 0.10 percentage points to 2.75 per cent and Royal Bank of Canada and Bank of Montreal reduced theirs by 0.15 points to 2.70 per cent from 2.85 per cent, effective July 16, 2015, signalling that banks are unlikely to pass on the full central bank rate cut to consumers. Government bond yields, which influence fixed mortgage rates, have risen since bottoming out in April and are likely to rise higher on the strength of the improving U.S. economy, said TD economist Diana Petramala. That means mortgage rates could potentially rise toward the end of the year despite the added monetary stimulus.

But others warned that by cutting rates to historic lows the central bank is sending a message to indebted Canadians that interest rates aren’t likely to begin rising any time soon. That will only add fuel to already hot housing markets in Ontario and British Columbia, where strong demand from home buyers and a shortage of new listings of single-family homes have driven up prices, while doing little for other local markets that have been struggling.

“The problem is we’re already tapping out on the supply side in the big cities,” said Phil Soper, president of national real estate brokerage Royal LePage, which advocated against a rate cut. “So we’ll see additional multiple offers and more upward pressure on prices. Affordability is already an issue in our biggest cities and I had just hoped we wouldn’t make it an even bigger issue.”

The country’s housing market, until recently a rare bright spot in an otherwise struggling economy, stepped off the gas pedal in June. Sales of existing homes fell 0.8 per cent, the first drop in five months, the Canadian Real Estate Association said.

Prices, however, have continued their ascent, growing by nearly 10 per cent over the past year. Much of that growth comes from the Greater Vancouver area, where average resale home prices have risen nearly 16 per cent since last June, and the Greater Toronto region, where prices are up more than 12 per cent. Outside of those markets, average prices have risen less than 2 per cent over the past year, and have fallen in nine cities, including oil-sensitive regions such as Calgary and Newfoundland.

Lower rates could exacerbate the growing regional divide, propping up housing markets in places like Toronto and Vancouver and delaying the long-awaited soft landing. “Any kind of cooling or slowdown that we would have expected six months ago is now being postponed once again,” said Royal Bank of Canada senior economist Robert Hogue.

A falling loonie may also spur more foreign investment in Canadian real estate, particularly from China, which could push up prices even further in major cities. Already Canadian investment in U.S. real estate has fallen in the past year on the heels of the softening exchange rate. “The weaker dollar might make Canadian property a little bit more attractive to some foreign investors whose currencies are holding up better,” said Bank of Nova Scotia senior economist Adrienne Warren.

The Bank of Canada acknowledged the impact of offshore money on the housing market, saying that “strength in British Columbia and Ontario appears to reflect local demand stimulated by historically low interest rates, as well as demand from foreign investors and recent immigrants.”

TD’s Ms. Petramala predicts the housing market will continue to soften for the rest of the year despite lower interest rates as labour markets finally feel the full effects of an economic slowdown. “We do think that eventually the economic conditions are going to catch up to the housing market and we’ll see a bit of an unwinding of recent strength over the second half of the year, even with the cut in interest rates,” she said.

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By the numbers

-16% Drop in existing home sales in Alberta, Saskatchewan and Newfoundland since November

9% Increase in existing home sales in the rest of Canada since November

14% The average yearly increase in the resale prices of homes in Toronto and Vancouver

-2.2% The average yearly decrease in the resale prices of homes in Calgary, Regina and St. John’s

Sources: Bank of Canada’s July Monetary Policy Report; Canadian Real Estate Association

 

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