Bank of Canada governor Mark Carney has made it clear that stimulus is his top priority

Bank of Canada governor Mark Carney's pledge to freeze record-low borrowing costs until June may be raising the chances of a bubble in home prices even as it helps the economy recover from its first recession in 17 years.

Sales of existing houses rose 74% in October from the January low, with prices up 21% from a year ago to a record C$341,079 (€220,000), partly because of Carney's promise. To prevent the economy from overheating, Carney will raise his benchmark rate by 125 basis points to 1.5% in 2010, while US Federal Reserve chairman Ben Bernanke will keep his key rate at 0.25%, said Stephen Gallagher, chief US economist at Société Générale.

"The worry has got to be that you might be getting a housing bubble out of this," said David Laidler, a former visiting economist and special adviser at the Bank of Canada and now a fellow at the CD Howe Institute, a Toronto research group. Laidler is a member of the institute's Monetary Policy Council, which studies central-bank decisions and said earlier this month that a "possible unintended effect" of Carney's commitment is "the buoyancy of mortgage lending, particularly variable-rate mortgages, and the housing market".

For now, analysts at Toronto investment banks Scotia Capital and RBC Capital Markets are recommending investors buy shares of companies such as Home Capital Group, even after the Toronto-based mortgage lender gained 161% since its 2009 low in February.

"The challenge now is getting the economy going and dealing with any potential bubbles down the road," said Ian Nakamoto, director of research at MacDougall MacDougall & MacTier.

Carney's situation reflects the conundrum faced by policy-makers who must balance stimulating their economies now with ultra-low rates against dealing later with the fallout.

"It is time to break the daisy chain of asset and credit bubbles and the global imbalances they spawn," Morgan Stanley Asia chairman Stephen Roach said earlier this month. "If we fail, there may not be another chance."

Carney, 44, has made it clear that stimulus is his priority. Only if the outlook for inflation shifts would the bank break its promise, he has said.

The central bank hasn't talked much about house prices, "to the bafflement of international investors", said Eric Lascelles, chief economist and rates strategist with TD Securities in Toronto. "It makes perfect sense that there is a good appetite for the housing market." What isn't clear is "whether this is a bubble in the making or simply a recovery from earlier softness".

The Trump Organisation, founded by Donald Trump, is building a 60-storey Trump International Hotel & Tower in Toronto. The residential condominiums sell for at least C$2m.

Canada will be "one of the first markets" that "we'll look at in the upswing", said Donald Trump Jr, 31, executive vice president of development and acquisitions.

Canadians are jumping at "what they perceive as a once-in-a-lifetime opportunity", said Peter Gilgan, 58, founder and chief executive of Ontario-based Mattamy Homes, Canada's biggest homebuilder.

The average five-year mortgage rate was 5.59% last week. In May it was 5.25%, the lowest since 1951, according to Bank of Canada figures. Sales of existing homes will rise 7% this year, according to the Canadian Real Estate Association, the second-highest total on record. Building permits jumped 18% in October, led by work on single-family homes and non-residential projects, Statistics Canada said last week. The total value of permits issued by municipalities rose to C$6.12bn, the most since September 2008.

The booming housing market partly reflects the strength of Canada's financial system, which was named the soundest in the world for two consecutive years by the Geneva-based World Economic Forum. No banks collapsed or sought a bailout during the global credit crunch. The US treasury department's Troubled Asset Relief Programme provided about $205bn in capital to banks.

Lending practices at Canadian banks have been more conservative than those at US financial institutions, said Ivan Wahl, chairman and chief executive of mortgage provider Xceed Mortgage Corporation. Subprime loans accounted for 5% at the peak of Canada's market in the summer of 2007. Even in that segment, default rates are about 3% compared to 30% in the US, he said.

"We've never had the traumatic problems," said Wahl, whose Toronto-based company targets customers who have trouble getting mortgages with the largest banks. "We have one of the most constructive, positive and stable real-estate markets in the world."

Canada's economy shrank for three quarters starting at the end of 2008, one period less than in the US. Its unemployment rate was 8.5% last month compared to 10% in the US. The 1.5% age-point gap was just under October's 1.6 point difference, which was the widest since at least 1976.

The state of the housing market reflects "an element of pent-up demand", Carney said. "Rates are exceptionally low, affordability has improved in part because of the low level of interest rates and in part because of some former price adjustments, and we are seeing a housing-price response."

His view is shared by Peter Aceto, chief executive of Toronto-based ING Direct Canada, a unit of financial-services company ING Groep. "I don't believe that there's a bubble," he said. "Most stories I hear are just typical Canadians trying to buy their first home or move up."

Aceto said he is seeing some unusual signs, particularly in Toronto, where houses are getting as many as five offers at a time and prospective buyers are wooing sellers with gifts.

"When Canadians are waiving conditions and paying 10% more than asking for a home, it does give you some pause," he said.

If policy makers are concerned about a bubble, they might look to tools other than interest rates to cool the market, said Brian Johnston, president of Monarch Corp, the Canadian division of Taylor Wimpey, Britain's largest homebuilder by market value.

"They might encourage lenders to be a little more circumspect in their mortgage qualifications; they may look at the amortisation periods on mortgages," he said. "I don't think they can control housing through fiddling with interest rates."

Last year, the department of finance said Canada Mortgage and Housing Corporation would limit amortisations to 35 years and 95% of value. The government's housing agency had offered insurance on loans worth as much as 100% of the home value and terms of up to 40 years since 2006.

Paul Lai and a dozen other estate agents camped out for 10 days along Toronto's Bloor Street in November for the chance to buy a home that won't be completed for four years. "Where else is the world do you have agents lining up overnight to buy a condominium?" said Lai. He was bidding for a client on a condo costing as much as C$500,000. "We're making history here," he said.

Bloomberg