TORONTO - Excessive real estate strength in Canada from ultralow mortgage rates could push the Bank of Canada to raise interest rates sooner or more aggressively than forecast, according to a TD Economics report on Tuesday.

The possibility is worth watching closely, the economics arm of Toronto-Dominion Bank argued, although it also said the most likely scenario is that the real estate market will moderate and inflation will remain in check.

The Bank of Canada has pledged to keep its interest rates unchanged at 0.25 percent until mid-2010, unless it sees a threat of inflation spinning out of control.

TD pointed to recent statements by the central bank that hinted that it would seek to lean against signs of emerging asset bubbles and that it is also monitoring developments in home prices.

In a recent speech, Bank of Canada Governor Mark Carney deemed the strength in existing home sales as temporary, reflecting pent-up demand and improved affordability. [ID:nN28517170]

The (Bank of Canada's) view at the moment is that the recent resurgence in real estate is temporary, but if it does not moderate in the coming year -- or worse still if price growth accelerates -- it could lead to an earlier and more substantial tightening in policy than currently anticipated, TD economists Craig Alexander and Grant Bishop said in the report on Tuesday.

The economists stressed that the central bank targets the rate of consumer price growth and does not target asset values.

The key issue is whether the low interest rate environment is creating an economic imbalance that requires a rebalancing of monetary policy, the TD economists said.

Canadian real estate markets have staged a stunning turnaround this year from the end of 2008 when sales and prices retreated sharply. The latest Canadian Real Estate Association data showed August home sales were up 18.5 percent from a year ago, while prices rose 11.3 percent nationally from a year earlier to an average C$324,779 ($306,395).

TD expects sales will cool in the coming months and for price growth to return to a mid-single digit pace after months of pent-up demand and tighter mortgage pricing.

The base-case economic forecast does not anticipate that hot real estate markets will force the Bank of Canada's hand, but it is a risk worth closely monitoring, the TD economists said.

TD expects the Bank of Canada will begin to gradually lift the benchmark overnight interest rate in the fourth quarter of 2010.

($1=$1.06 Canadian) (Reporting by Ka Yan Ng; editing by Rob Wilson)

Inflation Canada