Bank of Canada governor David Dodge is keeping a close eye on the high price of housing in Western Canada as he determines whether to revise interest rates.

During a news conference following a speech to the Vancouver Board of Trade, Dodge suggested the central bank's interest-rate policy has unduly influenced new-home prices.

"One worries about the structure of the mortgage market, that we may be actually facilitating a rise in the price of housing," said Dodge.

The Bank of Canada boss will decide Oct. 16 whether to change or maintain the current overnight interest rate of 4.5 per cent in wake of the loonie reaching parity with the U.S. greenback for the first time in three decades.

Photo courtesy of the Vancouver Board of Trade
Rising house prices in the West are worrying David Dodge.

But Dodge provided few clues on the bank's likely direction, contending he could not offer a "straight answer" on how he feels about the loonie's position in relation to the greenback, because his response depends on various market factors that are now under study.

He indicated high new-home costs alone probably won't justify a rise in the overnight rate.

Stressing that he has to consider the country as a whole, Dodge indicated he won't let strong Western Canadian economic conditions influence his decision.

Despite the downturn in the Canadian manufacturing sector, especially in Eastern Canada, he is confident that the national economy is adjusting and will be stronger in the future.

Realtors and developers say reduced commercial bank rates tied to a low prime are driving strong construction activity and prices in B.C., Alberta and Saskatchewan.

But Dodge feared the high cost of new homes will dampen the entire Canadian economy.

"We've been relatively clear, for a while, that we've been concerned about the relatively rapid rise in prices of new housing, because it does feed directly into the (consumer price index) with a weight roughly of about five per cent of the CPI," said Dodge. "So, when on average new housing is rising at eight per cent, that really puts an upward bias into the CPI, and it's clearly something that, in hitting our target (overnight interest rate), we have to be very concerned about."

In July, the Bank of Canada boosted its overnight rate by 25 basis points to 4.5 per cent.

But in September, the U.S. Federal Reserve lowered its rate, prompting the loonie to hit par with the U.S. buck. In August, as a result of problems with asset-backed commercial paper in the U.S. and lower long-term interest rates, the central bank bought back government bonds on the open market in a bid to bring the actual overnight rate closer to its target.

Canada's central bank views its overnight target rate as a key driver of monetary policy throughout the economy. An adjustment in the target can influence interest rates in financial markets as well as the cost of credit, spending, productivity, employment and inflation.

"It is absolutely true that, in some cities - Edmonton, Calgary, Vancouver, Regina - prices have moved up, really, quite rapidly because of very strong growth and the inflow of population in those centres," said Dodge. "Indeed, one would expect that to take place.

"But, I guess, what has worried us a little bit more is that, even if you abstract from those centres, what we're seeing is house prices rising faster - probably up to twice as fast as the rate of inflation in general.

"So we have been worried about that and we'll continue to worry about that," said Dodge.

But, he warned, in wake of problems with asset-backed commercial paper in the U.S., the Bank of Canada and other central banks may not have appreciated that the "securitization" of credit, or loans backed by cashflows generated by loan repayments and increasingly complex securities designed to generate higher returns on investments, has changed the relationship between the average price of credit and central bank interest rates.

Throughout his tenure, Dodge has adopted policies that mainly attempt to reduce inflation. He said Canada's terms of trade, or economic conditions, have not justified the loonie's rapid rise in relation to the greenback.

The Bank of Canada predicted in April that the loonie would increase seven per cent against the U.S. dollar within two years, but it climbed four per cent over the summer.

Dodge said risks to the Canadian economy are on the rise. But he will give more consideration to the weight of some risks rather than the total number.

High energy prices are also likely to factor into Dodge's decision. But he indicated he'll defer to market forces as he makes up his mind.

"You tell me what you think the (prices) of oil, copper, gold, natural gas, wheat and so on are all going to be," said Dodge. "Then I can give you some idea of what's likely to be happening. All we can do is look at futures markets."

During his speech, Dodge called on investors to demand greater transparency in financial markets, do more diligent research so that they can better understand their investments, and rely less on credit-rating agencies.

Dodge, who assumed his post in 2001 and will step down when his term ends next year, had planned to reflect on almost seven years as the Bank of Canada boss. But he felt more compelled to talk about market conditions over the previous seven weeks.

Darcy Rezac, the Vancouver Board of Trade's managing director, gave Dodge, a former Liberal deputy finance minister under Paul Martin, a tongue-in-cheek tribute.

"David, you've balanced the budget," said Rezac. "Now, you've balanced the dollar."

(Monte Stewart can be reached at monte@businessedge.ca)