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While monetary policy plays a crucial role in the housing market, lowering interest rates isn’t a silver bullet for resolving Canada’s housing affordability crisis, Bank of Canada Governor Tiff Macklem said today.

He made the comment in prepared remarks at the Montreal Council on Foreign Relations.

“Housing affordability is a significant problem in Canada—but not one that can be fixed by raising or lowering interest rates,” he said.

He said there were numerous reasons why housing supply has fallen short of demand for “many years,” including zoning restrictions, delays and “uncertainties” in the approval process and a shortage of skilled workers.

“None of these are things monetary policy can address,” he continued.

Instead, where monetary policy does have an impact is on housing demand, he said. One need only look back several years to the pandemic, when rock-bottom interest rates—alongside demand for more living space—contributed to a surge in housing demand, Macklem added.

Since supply couldn’t keep pace, house prices in Canada skyrocketed more than 50% in two years.

But even after the Bank’s rapid pace of rate hikes since March 2022—10 rate increases in 17 months—home prices have fallen much less than would have been expected due to the ongoing supply shortage.

On the other hand, Macklem did tout the Bank’s success in bringing down inflation from a high of 8% in 2022 to its current level of 3.40%.

As of December, the average price of a home was $657,145, according to the Canadian Real Estate Association. That’s down nearly 20% from the peak of $816,204 reached in February 2022.

Rather than making housing more accessible for homebuyers, the sharp pace of interest rate hikes has instead further eroded affordability by raising the cost of borrowing.

The impact of shelter costs on inflation

The Bank has recently started to acknowledge the impact high interest rates are having on shelter inflation, including in its latest Monetary Policy Report released last month.

The Bank expects shelter costs will account for about half of total inflation over the next two years, nearly double its current 26% weighting in the CPI basket, economists from National Bank pointed out.

“Acknowledging the problem is one thing, but whether the BoC will be willing to accommodate a source of inflation over which it has little control remains to be seen,” wrote Stefane Marion and Jocelyn Paquet.

“If the BoC remains reluctant to see through shelter inflation for too long, there is a risk that monetary policy will remain overly restrictive in the coming months, causing undue pain to the economy and exacerbating housing supply imbalances against a backdrop of surging population,” they added.

Governor Macklem recently addressed those who say inflation is practically back to its target of 2% when shelter costs—driven higher by the Bank’s interest rate hikes—are removed.

“First of all, Canadians are paying shelter costs. They’re a real cost and we can’t just ignore them,” he told the House of Commons finance committee last week.

Macklem also argued that if you strip shelter costs, then you also have to remove some of the “unusually weak” items that are impacting inflation on the downside. “If you use a more systematic approach to strip out the unusual ups and the unusual downs, inflation looks to be about 3.5%.”

Featured image by DAVE CHAN/AFP via Getty Images

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