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TORONTO (Reuters) - Weaker Canadian economic growth and an oversupply of condos will lead to a 5 percent drop in home prices in the first half of next year, a report released on Monday by Bank of America Merrill Lynch said.
Canadian housing prices are overvalued by as much as 10 percent, the report said, with demand spurred by record-low mortgage rates spawned by the Bank of Canada's decision to keep its key interest rate at an ultra-low 1 percent.
"The combination of weak growth, large supply in certain large markets and the relative valuations themselves conspire to warrant a contraction (in 2012)," said Bank of America economist Sheryl King.
"A 5 percent contraction is pretty modest by historical standards," King added. "I don't think that it's a very bold call at this point."
BofA forecast home prices would contract in the first half of 2012 as demand slows in a tougher job and income-growth environment. It said, however, that they would end the year flat as economic activity accelerates.
The majority of the correction will come in Toronto area, where an oversupply of condominiums is expected to push prices down, the report said.
"We estimate there are already enough units in the pipeline to satisfy fundamental demand for the next five years," it said.
Household debt, which rose to a record high in the third quarter as mortgage and consumer credit increased, and an unemployment rate that BofA predicts will rise to 8 percent will also hit demand.
The BofA outlook was more bearish than a November report by Canada Mortgage and Housing Corp. It forecast the average home price in Canada will reach $368,200 in 2012, up from $363,900 in 2011.
"I haven't read the CMHC report but I would assume they probably have a more optimistic outlook for economic activity for 2012," King said. "The growth in the first half of the year is going to be really quite weak. We're already starting off domestically on a pretty weak footing, having lost 73,000 jobs in the past two months."
Housing starts fell in November to a seasonally adjusted annualized rate of 181,100 units from an upwardly revised 208,800 units a month earlier, according to the CMHC's December results. Analysts had forecast 200,000 starts in November.
Nationwide, prices rose 2.5 percent in the 12 months to October and since mid-2010 have been well above the pre-recession levels of 2008, according to Statistics Canada.
Editing by Peter Galloway