Get ready for a Canadian housing crash.
That's the forecast from the folks at research firm Capital Economics, who say the collapse in house prices will feed into economic weakness and cause the Bank of Canada to back track on its insistence that the next move in domestic interest rates will be up.
"Home sales have slumped in recent months, not just in response to the tightening of mortgage lending standards. We fear this adjustment is only just starting and anticipate that the resulting excess supply of homes for sale will eventually drive home prices down by as much as 25 per cent," the firm says in a note to clients.
If this gloomy forecast comes to pass, many Canadians will experience the pain of being underwater borrowers, just like in the U.S., where many home owners owe more on their mortgages than their residences are worth.
Citing Canada Mortgage and House Corp. figures, Capital Economics, one in 10 owners has less than 10 per cent home equity, so a decline of a quarter in home prices would put a substantial number of people underwater.
A huge drop in housing prices will have ripple effects throughout the economy, and be a major depressant on growth. Capital Economics points out that residential investment currently equals 7.3 per cent of GDP, compared to its long term average of 5.8 per cent.
"There is a good chance that share will drop below its average, making it a significant drag on overall GDP growth in both 2013 and 2014," the firm says.
Domestic housing will compound any slowdown in growth caused by reduced global demand for Canadian commodity exports.
That's why the firm says the Bank of Canada's recent statement of a tightening bias for monetary policy will be revoked, and that government bond yields are likely to fall.
"The bias policy makers have towards tightening policy looks, in our view, to be increasingly untenable," it says.