Canada’s central bank is close to ending its program that contributed to rocket fuelling home prices. The Bank of Canada announced that it will reduce its quantitative ease program (QE). QE is a key contributor to the flood in cheap cash that has helped push up home prices. The program is nearing its end and the increase in home prices will likely disappear.
Quantitative Ease
Central banks use quantitative ease (QE), a policy tool, to inflate the economy. The BoC pumps billions of dollars each week into the bond markets, driving prices higher. Their goal is not to find a deal, but rather, it’s like a panicked customer looking for toilet paper. It’s to find as much of it as possibleRollsThey will find bonds wherever they are available. They increase demand by a buyer who has unlimited resources and push yields down. They have effectively flooded the market, making it very difficult to borrow money.
Because credit markets compete for the same capital it is cheaper to borrow all credit. It will be even cheaper than if the interest rate were to be cut. They want people borrowing the money to invest in the economy and to increase demand. Inflation rises because of increased demand. It’s a success.
This program is controversial and can cause a lot of problems that are not intended. Rising inequality has been a topic the BoC has spoken of. Higher asset prices (including housing) are another. There is now a petition to end any future use of Canada.
With inflation on the rise, people are now considering whether the higher goal is possible. Perhaps.
Bank of Canada to Reduce QE to $2 Billion per Week
That’s right, it’s not a typo. Billion with a B. Each week. Today, the BoC made widely anticipated announcements about their plan to reduce their QE program. QE will now be reduced to $2 billion per week from $3 billion. This year, the program was cut from $4 billion to $2 billion per week. Its size has been reduced by a third and is now half the size it was earlier in the year.
Experts believe that QE will end, particularly with the economy recovering at such a rapid pace. It is difficult to predict when it will end. Desjardins stated earlier today that they believe the central bank will end the program by the fall. RBC and BMO both said that they expect it to happen early next year. All the parties mentioned above predict a rise in interest rates mid-next.
Low Interest Rates Help to Push Home Prices
Low-interest credit has been a key factor in high home prices being supported. Although the BoC denied that cheap credit was a contributing factor to higher home prices they actually don’t believe so. They recently updated the forecasting model to account for credit’s impact on home prices . It was an “innovation” that low-interest credit could do this. This has been known for many years by the real estate industry.
Lower mortgage rates create two pressures on home prices: both supply and demand. A borrower can make their home purchase more affordable by getting a mortgage at a lower rate. They are more competitive than existing buyers, which makes prices rise.
How can a buyer compete with other buyers in the market by getting cheap money? This applies to existing buyers too. They now have more credit available than before rate cuts and QE. This allows them to compete. All buyers now have more money to compete against each other.
They can also absorb rising home prices easier. This makes sense and is why central banks have lower borrowing costs. The BoC disagreed with that view earlier this year and attributed it to exuberance. Evidently, people were not supposed to use the capital that the BoC desired. You stupid people.
What does this mean for mortgage rates? Tapering QE decreases market liquidity. Normal circumstances will result in higher borrowing rates if there is less liquidity. The supply of capital is what will determine if it increases borrowing rates.
