The Bank of Canada has reduced its overnight interest rate target by 25 BPS to 4.75 per cent, the first reduction in the rate since the central bank instituted a policy of rapid rates increases over two years ago to slow a rapid increase in inflation.

The bank’s effort to get inflation moving back toward its target of about two per cent annually has been cited as one of the key factors in a precipitous drop in the Canadian housing development and construction markets despite the country’s burgeoning population.

Bank of Canada governor Tiff Macklem gave no indication of whether this might precipitate a trend toward further rate reductions in comments following the announcement.

“We are taking our interest rate decisions one meeting at a time,” Macklem said.

“Further progress in bringing down inflation is likely to be uneven and risks remain. Inflation could be higher if global tensions escalate, if house prices in Canada rise faster than expected or if wage growth remains high relative to productivity.”

How the rate reduction, announced Wednesday morning, will affect the market remains to be seen. As the country’s population has grown by between 750,000 and a million annually during the past couple of years, pressure on the housing sector has been intense.

Higher borrowing costs have discouraged many potential homebuyers, creating intense demand in the rental sector and leading to rapidly rising leasing rates.

The cost of borrowing, high land values, elevated construction and labour costs, supply chain issues and other factors have also made it more difficult for many developers and homebuilders to get new projects into the ground.

Rate reduction could spur housing costs increases

In the Greater Toronto Area, for example, fewer than 1,500 new condos were sold in Q1 2024 - two years ago that figure was over 10,000. Dozens of development projects, both for condos and purpose-built rental buildings, are either delayed or postponed indefinitely.

"Our impression is that many buyers have been waiting for a rate cut before taking action. Now - with clear evidence that we're moving in the right direction - we think purchasers will be more invigorated," said Dayma Itamunoala, vice-president and head of Colliers' multifamily investment team in Toronto, in a note following the announcement.

While the rate cut will be welcomed by the development community, a possible increase in homebuying activity could quickly lead to escalation in the selling prices for all types of dwellings. Due to pent-up demand from people waiting to enter the market, potential buyers could go from one difficulty – higher borrowing costs – to another if home prices spike.

“The long-awaited cut to the overnight lending rate has arrived. The Bank of Canada held its key lending rate at a two-decade high of five per cent for the past 11 months and more than four years have passed since the last time that the rate was reduced,” said Phil Soper, president and CEO of Royal LePage, in a statement shared with RENX Homes.

“Our research indicates that half of sidelined homebuyers in Canada plan to resume their home search plans once the bank rate begins to drop.

"This will no doubt spark activity and put upward pressure on home prices in the second half of the year.”

The bank cited several reasons for its decision today:

• at 1.7 per cent, first-quarter GDP growth was slower than forecast as weaker inventory investment dampened activity;
• consumption growth was solid at about three per cent and business investment and housing activity also increased;
• labour market data show businesses continue to hire although employment has been growing at a slower pace than the working-age population;
• wage pressures remain, but look to be moderating gradually. 

Overall, the BoC reports the latest data suggests the economy is still operating in excess supply.

Specific to the housing and development industries, the Consumer Price Index's (CPI) so-called “shelter inflation” has been identified as a core reason inflation remained above the BoC target. And it “remains high” the bank stated.

In a Pulse blog posting this week, BGO's Phil Stone, managing director and head of Canadian research, and Tom Vo, vice-president, economics and research, commented on this factor. 

"Headline CPI (2.7%) is trending in the right direction and on pace to meet target by 2025, and more importantly, core inflation has also slowed to 2.7%. Interestingly, high mortgage interest expense is now one of the main drivers of inflation," they wrote.

"Canada is the only country in the world that includes this in its CPI calculation. Excluding mortgage interest costs, inflation is below 2.0%, well within the Bank of Canada’s target range."

The BoC’s preferred measures of core inflation also slowed and three-month measures suggest continued downward momentum, the BoC stated in its announcement. 

“Recent data has increased our confidence that inflation will continue to move towards the two per cent target. Nonetheless, risks to the inflation outlook remain,” the bank stated in the announcement.

“The bank remains resolute in its commitment to restoring price stability for Canadians," the announcement concluded.

RENX Homes will update this breaking news with new quotes and information as it becomes available.