Senior decision-makers at the Bank of Canada expressed their concerns ahead of announcing a rate cut this month, fearing that easing monetary policy could lead to increased overheating in the housing market.

This is according to the latest summary of the Bank of Canada's discussions at the monetary policy meeting on June 5, where its six-member governing council voted to lower the interest rate from 5.00% to 4.75%.

In making the decision, council members expressed their growing confidence that inflation would continue to progress toward the 2% target, especially as the bank's preferred measures of core inflation had declined for four consecutive months.

The summary stated: "They also agreed that if inflation continues to retreat and remains on a sustainable path toward the 2% target, it would be reasonable to expect further interest rate cuts."

They noted that any easing is expected to be gradual, consistent with the anticipated steady decline in inflation until it reaches the neutral target by 2025. Since the timing of any additional rate cuts will depend on incoming data, the members agreed that monetary policy decisions would be made "one step at a time."

Risks to the inflation path

Although inflation continues to trend downward, members spent some time discussing several risks that could threaten the future path of inflation and economic growth.

They pointed out that interest rate cuts "could lead to a heated housing market, given the pent-up demand."

A heated housing market could result in rising prices, which may reignite inflationary pressures and complicate the bank's efforts to maintain stable economic growth.

The members also noted risks to economic growth, as consumers curb spending in response to higher payments when renewing mortgage terms. The Bank of Canada estimates that nearly 80% of all mortgages due as of March 2022 will be up for renewal by the end of 2024.

The summary indicated that "the large number of households renewing mortgages at higher rates and with higher payments in 2025 could lead to reduced spending, dampening economic activity and inflation more than expected."

On the other hand, the members also acknowledged that consumption could rebound more than expected with a recovery in consumer confidence, while "ongoing strong wage growth" and weak productivity could lead to inflationary pressures.

According to a report by Michael Davenport, an economist at Oxford Economics, the shock of mortgage payments will hit households in the coming months, leading to reduced consumption in the second and third quarters, potentially "helping to push the economy into a modest recession this year."

This could drive the Bank of Canada's interest rate down from 4.75% to 2.25% by late 2026, according to Davenport's forecasts.

However, if the economy avoids contraction, labor markets remain resilient, wage growth does not slow, or if home prices recover too quickly, the path of easing taken by the central bank could be at risk.

Davenport warns that if any of these scenarios materialize, "the bank may delay easing and keep interest rates higher for a longer period, or even resume rate hikes later this year."

The Bank of Canada is scheduled to release its next interest rate decision on July 24.