The Canadian landscape is littered with unfulfilled prophecies of imminent housing collapse. It goes without saying that a housing correction has not yet occurred. How has this been avoided? A new report entitled, “Economic Compass: Canada’s Debt Threat” by Eric Lascelles, Chief Economist for RBC Global Asset Management, details Canada’s debt levels and its impact on housing affordability, the economy, and what we can expect in the near future.
Below is an excerpt:
Calgary and Edmonton are often identified as other potential trouble spots for the Canadian housing market. They have been through classic boom-bust cycles in recent years, in line with the fortunes of oil and gas. Broadly, these cities align with the Toronto findings. Home prices are perhaps a touch too high today, but will be substantially too high once interest rates rise.
Clearly, home prices have limited scope for further appreciation, at least once rate hikes begin. The best case is stagnation for several years as income growth gradually whittles away the affordability gap. Equally likely is a moderate decline in prices of 10% or less, a scenario made even more likely if home prices keep rising until the first rate hike (Exhibit 10).
It is unlikely that the housing market will crack of its own initiative, because current carrying costs on a national basis are manageable, and materially different from the tail end of the 1980s when very poor affordability prompted a multi-year decline. Rising interest rates will be the catalyst, and the longer this is delayed, the nastier the future affordability problem will become. In the meantime, the piecemeal introduction of regulatory reforms to the housing market over the past few years is exerting a slight drag.
Other highlights of the report include:
- A central risk to Canada’s economic recovery is its record household debt burden.
- Currently, the load is surprisingly affordable, given very low borrowing costs.
- Rising interest rates will compromise this, rendering home prices materially too high, and forcing some retrenchment in consumer and housing activity.
- This will be quite painful for a small subset of households, but does not represent a systemic risk. It will slow economic growth, but not devastate it.
- The Bank of Canada is arguably tightening monetary policy later than it should be.
- The reality is that the Bank of Canada cannot afford to delay raising interest rates…the longer the bank delays, the more marginal borrowers will enter the market and be walloped when rates rise, and the further home prices will go above their equilibrium levels, only to tumble later
- The risk is greater and more immediate for the 35% of Canadian mortgage holders in possession of variable-rate mortgages and greatest for those who have just purchased a home.
