Canada's hot housing market isn't in bubble territory, according to a new report which argues that it's the federal government's "dangerous" tightening of mortgage rules that poses the biggest threat to home prices.

That view, from housing market economist Will Dunning, runs contrary to many readings of Canada's housing sector.

Many analysts have examined the state of housing in this country and declared it overheated, overvalued, and ripe for a tumble in prices as soon as interest rates begin to rise.

Nonsense, says Dunning, who runs a real estate market research firm and frequently consults for the mortgage industry.

For one thing, he dismisses some of the data that groups like the OECD have used to justify their diagnosis of a housing bubble as "badly flawed."

The OECD report found that based on the ratio of house prices to rents, Canadian real estate is overvalued by as much as 60 per cent. But Dunning says the particular house-price-to-rent ratio used is inaccurate because it overestimates house price growth and underestimates the pace of rent increases.

Government actions to slow the housing market are not only unnecessary. They are also dangerous. - Housing economist Will Dunning

Looking at house prices, Dunning says there is room to accommodate a sizable increase in house prices of as much as 25 per cent over the next two years, along with a rise in interest rates of as much as one percentage point from current levels.

"Rather than being overvalued, house prices in Canada are fairly valued, and they may even be undervalued," he writes in a report released Wednesday.

Dunning instead argues that it is Finance Minister Jim Flaherty who has created "dangerous" conditions for the housing market by tightening mortgage rules on four separate occasions.

"Government actions to slow the housing market are not only unnecessary," says Dunning. "They are also dangerous."

He says the most recent change, to eliminate 30-year amortizations for insured mortgages, "took demand out of a housing market that was already in a state of balance." He likened the effect of that one rule change to a one percentage point increase in mortgage rates.

"The deliberate reduction of housing demand, which is now clearly visible in the new and existing arenas, creates a risk that prices could fall, unnecessarily. Once prices start to fall, the outcome is unpredictable," he writes.

Prices hit record highs

Dunning's report comes as a closely-watched indicator showed Canadian housing prices hitting a record high. The Teranet-National Bank composite price index rose 0.3 per cent month-over-month in February, led by gains in Western Canada.

Over the last 12 months, the index has increased by 5.0 per cent nationally. Prices in Calgary rose 9.6 per cent year-over-year and in Vancouver by 7.7 per cent. Toronto prices were up 6.1 per cent.

But some markets saw year-over-year drops. Prices in Victoria fell 3.4 per cent, Halifax dropped 4.7 per cent and Ottawa-Gatineau slipped 0.6 per cent.

The Teranet-National Bank index tracks average home prices in 11 metropolitan markets based on data collected from public land registries.