After a year-long slump, Canada's housing market is showing early signs of recovery, and realtors say pent-up demand, chronic shortage of homes, a spike in rents and hopes of an interest rate cut may fuel a rally in the sector that could reignite inflation.

With most factors beyond the central bank's control, the only lever the Bank of Canada (BoC) can pull is through monetary policy, although Governor Tiff Macklem explicitly said on Tuesday that interest rates alone can't "fix" higher shelter cost, which is the biggest contributor to inflation.

Yet, bringing down interest rates from a 22-year high of 5% early could spark a frenzy in the housing market that the central bank would want to avoid.

Some buyers are already coming out of hibernation.

A three-bedroom townhouse listed for C$828,000 ($611,883) last month in Newmarket, a thriving town outside Toronto, received 40 offers and sold for C$1.06 million, said John Pasalis, whose Realosophy Realty marketed the property.

"All of these multiple offers ... are working now because demand is a lot higher than in the fall," Pasalis said.

Pasalis, like five out of six of the real estate brokers Reuters spoke to, sees a rebound in the housing market. For instance, home sales in January in and around Toronto jumped almost 10% on the month and surged 37% from a year earlier, data showed on Tuesday.

Meanwhile, annual rents in December rose by 8.6% compared with a year ago, and January was already showing signs of another uptick, further supporting housing demand.

For Macklem, high mortgage and rental costs present a significant hurdle in managing inflation. The bank last month said price growth in the shelter sector would create a "material headwind" to returning inflation to the 2% target.

The minutes of the governing council meeting on Wednesday showed that the central bank was fretting about a rebound in housing.

Canadian money markets have pushed back earlier bets for a March interest rate cut, now seeing a nearly 100% chance of a drop in June. Expectations for one in April have been hovering around 40%.

 

HOUSING SHORTAGE

With some fixed-rate home loans having eased by almost 60 basis points since October to below 5%, buyers are in search of financing options.

Traffic at ratehub.ca, an online interest rate comparison platform, picked up in the last month on an annual basis, James Laird, its co-founder, told Reuters. But he cautioned that it was "intent as opposed to activity."

Meanwhile, the housing shortage shows no signs of abating, despite numerous government initiatives.

Canada will need to grow its housing stock by an average of 315,000 units every year between now and 2030 to meet demand, said Robert Hogue, assistant chief economist at the Royal Bank of Canada.

"That's more than a third above the pace of housing completions in the past few years," he said.

Mike Moffatt, founding director of the Place Centre, a think tank focused on sustainable housing, said first-time buyers are mostly waiting.

Demand "is going to absolutely explode when rates come down and first-time homebuyers can start qualifying for mortgages again," Moffatt said.

Economists said the central bank's recent comments on its lack of control on housing prices was preparing Canadians to gear up for a pickup in housing activity.

"I suspect the BoC would fully expect housing activity to pick up alongside interest rate cuts. I think what would worry the bank is a spike in prices," Hogue said.

($1 = 1.3532 Canadian dollars) (Reporting by Promit Mukherjee in Ottawa and Nivedita Balu in Toronto; Additional reporting by Fergal Smith; Editing by Steve Scherer and Mark Porter)