High household debt and elevated housing prices have become bigger vulnerabilities in the past year, but the economy can still handle the rising interest rates needed to tame inflation, Bank of Canada governor Tiff Macklem said Thursday.
“We think the economy needs higher interest rates, and it can certainly handle higher interest rates,” he told a news conference in Ottawa discussing the central bank’s latest financial system review.
The review notes high debts and home prices have increased the downside risks to overall economic growth, as rising rates meant to counter inflation increase the chance of households having to divert consumption towards debt repayments.
However, Macklem emphasized the overall financial health of Canadian households, as the average net worth increased by about $230,000 during the pandemic, and the focus of the central bank on reducing inflation over concerns of how higher rates may affect the housing market.
“Our primary focus is getting inflation back to target. You know, monetary policy is not housing policy,” he said.
“The increases in housing prices we’ve seen have been unsustainably elevated and we are expecting to see some moderation in housing activity and frankly, that would be healthy.”
He said that while the housing market is an important part of the economy, and the bank is watching the dynamics closely, the bank needs to slow demand in the economy and bring it in line with supply.
The bank has indicated, and Macklem repeated Thursday, that it may have to move its key interest rate to upwards of three per cent to bring inflation back on target. He said the bank may need to “move more quickly, may need to take a larger step” to avoid inflation becoming entrenched.
Read the full Opening Statement
The Bank of Canada raised its key interest rate target by half a percentage point last week to 1.5 per cent, a move that prompted the big commercial banks to raise their prime rates.
The report Thursday noted that increasing rates will put strain on mortgage holders, especially those who bought into the housing market during the pandemic as an increasing number of households have stretched themselves financially to purchase a home.
To illustrate the risks, the central bank ran a hypothetical scenario where five-year variable- and fixed-rate mortgages taken out in 2020 and 2021 renewed at median rates of 4.4 per cent and 4.5 per cent, respectively, in 2025 and 2026.
In this scenario, households that took out a fixed-rate mortgage during that period would see a median increase in their monthly payment of $300 or 24 per cent, while high loan-to-income ratio borrowers with a fixed-rate loan would see a median increase of $490 or 26 per cent.
However, those with variable-rate mortgages would face even larger increases with a median increase of $720 or 44 per cent in their monthly payment at renewal. High loan-to-income ratio borrowers who opted for a variable-rate loan would see a median increase of $1,020 or 45 per cent in their monthly payment.
Higher mortgage servicing costs mean less money to spend elsewhere which could have a negative hit on the overall economy, the report noted. Looking ahead to the first quarter of 2024, the trends have increased the probability of negative growth to 15 per cent, up by five percentage points compared to what it would have been had debt levels not changed during the pandemic.
Rising rates also increase the risk of a correction in the real estate market, which would erode equity and the ability for households to respond.
The report notes that the recent run-up in home prices, which gained about 50 per cent in the first two years of the pandemic, has been fuelled in part by increased buying by investors and the overall expectation that prices would continue to rise, both of which could “amplify” the decline in prices as the market reverses.
The real estate market has already started to cool since the bank has started raising its key rate, but the central bank said it’s too early to tell if it’s the start of a deeper, lasting decline.
The financial review noted that Canada’s banking industry could weather a downturn in both the housing market and overall economy. A stress-test where the economy declines 5.8 per cent over six quarters showed that while it would lead to sizable decline on bank capital buffers, the banks would still be broadly resilient.
The Bank of Canada noted in its review that other vulnerabilities to the financial system include cyber threats given the interconnected nature of the financial system, a risk that has increased from Russian aggression related to its invasion of Ukraine.
It said Russia’s invasion of Ukraine has also further complicated the transition to a low-carbon economy and increased the risks of a repricing of assets exposed to climate change.
But the key challenge for the bank remains high inflation rates, which Macklem said the bank hopes to reduce without pushing the economy into a recession despite the increased complexity of the challenges.
“Our objective is very much to to achieve a soft landing with inflation coming back to target, but it is going to be delicate and there are risks around that.”
This report by The Canadian Press was first published June 9, 2022.
NEWSFLASH: @bankofcanada‘s Tiff Macklem—when asked today if households could handle a rate hike over 50 bps—said the BoC “may need to take a larger step.”
Central bankers don’t make such statements loosely.
OIS probability of a 75 bps hike on July 13 quickly rose up near 50%.
— Rob McLister (@RobMcLister) June 9, 2022
Far too little, far too late. Even with today’s 50 bps hike, the #BankofCanada rate translates into a -5.3% real rate, the lowest since the 1970s. Soon Canadians will be paying for double digit inflation and they can thank their very government friendly central bank for that.
— Jeff Rubin (@JeffRubin) June 1, 2022
“Part of the exceptional increase in house prices observed since the start of the pandemic may have reflected extrapolative price expectations”
The Bank of Canada pointing out what should be obvious now
The past 2 years was in fact a housing bubble! 2/https://t.co/8wXIgkODNh pic.twitter.com/A8PKBklMhJ
— John Pasalis (@JohnPasalis) June 9, 2022
I’ve known Jamie for years. Good insight into market trends. Very good track record. We’ve had many good natured debates in his office. This is as bearish as I’ve ever heard him. https://t.co/AGcjNSeE1I
— Ben Rabidoux (@BenRabidoux) June 8, 2022
Contrasts: As a percentage of increase the BoC raised rates 38% in a few months, right now we are going well over 100% increase
BTW in 1989 – 1990 Fixed rates also bounced up over 40%, today we are about 120% increase YoY
BUT in 1990 we had nothing like the low-rise Supply
3/
— Ron Butler (@ronmortgageguy) June 8, 2022
Real Estate is local and as we have already observed the regions that experienced the wildest house price increases are experiencing the most acute price drops
Based on the massive shift in mortgage and HELOC rates the greatest chance is continued decline
Next key Factors?
5/
— Ron Butler (@ronmortgageguy) June 8, 2022
2017 had some neighborhoods stay down for a few years but prices generally restarted a year later
BUT 1990 was a 6 year plateau of never moving prices
VERY Damaging because RE sentiment became completely negative, Agents quit in droves
So what now?
We shall wait and see
— Ron Butler (@ronmortgageguy) June 8, 2022
Lost in y/y comparisons to a crazy-record year in 2021, is that a lot of 💰 still being committed to RE.
YTD May residential $ volume in GTA (TRREB):
2017 $41.1 B
2018 $25.6
2019 $28.2
2020 $23.4
2021 $63.2
2022 $52.1So this year is about same as 2018/19 (or 2019/20) combined.
— Scott Ingram REALTOR® (@areacode416) June 9, 2022
YTD GTA resale housing transactions are down 31% y/y (40.8K vs. 58.9K).
But due to increased prices, dollar volume is only down 18% ($52.1B vs. $63.2B).
— Scott Ingram REALTOR® (@areacode416) June 9, 2022
GTA-wide sold price as % of list price this year:
Jan 112.7%
Feb 116.0%
Mar 112.9%
Apr 107.0%
May 103.0%Sure has dropped quickly.
— Scott Ingram REALTOR® (@areacode416) June 9, 2022
Canadian housing is going to feel the impact of fast changing mortgage rules and pricing.
Get a broker.
Mortgage rates are all over the place. Bridge loans being cancelled. Rate holds not being honored.
Uncertainty is bad for prices because buyers need to price in extra costs.
— Timm McLean (@Timm_McLean) June 9, 2022
Average sale-to-list-price ratio fast approaching 100% in the GTA.
Currently at 102%.
I’ll say this louder, one last time for my realtor friends at the back:
UNDERPRICING EXPEDITES DOWNWARD PRICE DISCOVERY.
Start pricing properly.@TheHabistat pic.twitter.com/BQsNVQ25Jm
— Daniel Foch (@daniel_foch) June 9, 2022
Don’t know who needs to hear this but Bank of Canada is overestimating the housing markets ability to handle higher rates. Position accordingly.
— Steve Saretsky (@SteveSaretsky) June 9, 2022
The U.S. housing market is at the beginning stages of the most significant contraction in activity since 2006.
It hasn’t shown up in many data series yet, but mortgage applications are pointing to a large decline over summer.
Purchase apps down 40% from seasonally adjusted peak pic.twitter.com/s4Wl712MZZ
— 📈 Len Kiefer 📊 (@lenkiefer) June 9, 2022
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