With interest rates set to keep rising, the Bank of Canada is sounding the alarm on the risk record high house prices and an increasing number of households with high mortgage debt could have on the Canadian economy.

鈥淚n Canada, elevated levels of household debt and high house prices remain two key interconnected vulnerabilities,鈥� the bank said in its annual Financial System Review.

Despite house prices increasing 53% nationally between April 2020 and April 2022, the bank is concerned that recent homebuyers lack the equity in their home to withstand a 鈥渟ignificant price correction鈥� and would 鈥渇ace more financial strain when they renew their mortgages at higher rates.鈥�

That price correction in housing prices could be coming soon, according to Bank of Canada Governor Tiff Macklem, who says it would be 鈥渉ealthy鈥� to see a dip in house prices. 

鈥淭he level of activity the increases in housing prices we've seen have been unsustainably elevated and we are expecting to see some moderation in housing activity,鈥� said Macklem. 

The bank says many of the recent homebuyers 鈥渇inancially stretched鈥� themselves to purchase a property at record prices due to a 鈥渇ear of missing out鈥� on the continued increase of house prices across the Canadian housing market.

Last week, the Bank of Canada signalled it is willing to hike its key interest rates above the previous target of three per cent to deal with what Macklem says is 鈥渁n overheating economy.鈥� 

鈥淲e think the economy can handle higher interest rates, we think the economy needs higher interest rates and in our last decision we indicated that we were prepared to move more forcefully if needed," said Macklem.

The next interest rate hike is scheduled for July 13, when the bank is expected to hike rates by at least 50 basis points. When asked by reporters if the bank was considering a larger increase of 75 basis points, Macklem would not rule it out, saying 鈥渨e may need to move more quickly, may need to take a larger step鈥� to deal with inflation. 

The bank blamed the massive run-up in house prices on strong demand relative to supply and an increase in the number of investors snapping up properties.

Investors accounted for 22% of property purchases with mortgages in the fourth quarter of 2021, up from 19% in 2019, according to the bank.

Those investors are taking out existing equity in other properties they own to make new purchases, which the bank says 鈥渉ighlights the feedback loop between rapid gains in the house prices and the strong demand for housing that investors generate.鈥�

House prices remain at all-time highs across Canada but the bank warns that it鈥檚 too soon to tell if the recent decrease in resale activity and prices are 鈥渢emporary or is the start of a deeper, lasting decline.鈥�

If investor demand dries up for Canadian housing, the bank warns that would 鈥渁mplify the downward pressure on prices鈥� and could 鈥渓ead to an abrupt price correction in the future.鈥�