Royal Bank of Canada is warning that Canadian homebuyers are feeling the heat from the rapid increase in interest rates.

In a note to clients Thursday, RBC Assistant Chief Economist Robert Hogue said he expects prices will continue to decline as the central bank increases the cost of borrowing, which RBC sees topping out half a percentage point above its earlier projections.

“The national composite MLS Home Price Index fell a further 1.6 per cent month-over-month in August. It’s now down 7.4 per cent since February’s peak, within striking distance of the eight per cent peak-to-trough decline recorded during 2017-19 downturn,” he stated.

“We see that trend continuing in the near term with the Bank of Canada poised to stay in tightening mode until the end of this year. We have updated our policy rate call to four per cent by December, up from the 3.5 per cent we previously expected.”

RBC has joined TD and Scotiabank in forecasting the terminal rate – essentially where a central bank ends its rate increase or decrease cycle – at four per cent. That’s well within so-called restrictive territory where rates constrain economic growth, with the central bank previously stating that anything above three per cent will put the brakes on output.

The central bank has increased its benchmark rate to 3.25 per cent from the 0.25 per cent pandemic trough in a bid to tamp down inflation, which is running at 7.6 per cent, more than three times the central bank’s target.

Hogue said that push into restrictive territory will further curb housing activity over the next 18 months as potential homebuyers are pushed to the sidelines due to the higher cost of borrowing.

“The likelihood the Bank of Canada will take its policy rate deeper into restrictive territory by year-end is poised to keep buyers on the defensive in the coming months,” he said.

“Higher interest rates will disqualify more buyers from obtaining a mortgage and shrink the size of a mortgage others can qualify for. We project home resales to fall 23 per cent in Canada this year and a further 15 per cent next year.”

Overall, Hogue said he thinks prices will bottom out by early next year, though the pain will be deeper in Ontario and British Columbia, where prices surged during the pandemic.

“We think the market will adjust to higher interest rates by early 2023. Any recovery will likely take a few months to tighten demand-supply conditions, placing the bottom for prices around spring time (overall for Canada),” he said.

“We expect benchmark prices will be down approximately 14 per cent from the recent peak nationwide. On a provincial basis, we project Ontario and British Columbia to record the largest peak-to-trough declines [16 per cent], and place Alberta and Saskatchewan at the other end of the scale at [declines of four per cent].”