Bank of Canada’s Worst Case Scenario Is Here, Except For A 40% Drop In House Prices

Canada’s central bank flooded real estate markets with cheap cash when the pandemic hit, and we may know why. Hilliard MacBeth, a prominent Canadian wealth manager, released a research note for clients last week. In his post, he dissects a Bank of Canada (BoC) staff research note from 2019, testing the resilience of the banking system. All of the central bank’s most serious and outlying scenarios have arrived, except for one – a decline in home prices.

The BoC Models and Tests The Resilience of Banks With Outlying Scenarios

The BoC regularly models hypothetical situations to test the resilience of banks. In this case, they worked with the IMF to test against an extreme hypothetical situation. The situation, while extreme, is also considered possible – so it has real value. Now, to clarify – this isn’t a forecast of what happens. However, it’s an educated grouping of indicators that often accompany each other.

Economies don’t work in a vacuum, so typically there’s a cascading effect. Usually a drop in consumption leads to a loss of employment. That drop of employment feeds a further loss of consumption. Eventually that impacts how much people can pay for home. The exercise isn’t a forecast, but it gives us interesting insights to how an economy is expected to work. The point is actually to determine if banks can survive a worst case scenario. Spoiler: They can, it’s just not pretty.

The “Adverse” Scenario Is The Worst Recession Canada Has Seen

In the BoC’s adverse scenario outlined in 2019, Canada’s GDP took a large hit, unemployment spiked, and house prices tanked. The scenario sees Canada’s GDP dropping 8.2%, unemployment peaking at 12.6%, and house prices dropping 40.9%. They also assume a duration of 7 consecutive quarters. This scenario is much worse than any other previous scenarios Canada has seen. In fact, they’re testing for what seemed like a near doomsday scenario.

Bank of Canada’s Worst Case Scenario Is Here, Except For A 40% Drop In House Prices - SS

Canada’s Adverse Scenario Is Here, Except For Real Estate Prices

MacBeth points out almost all of these indicators have been breached, except for house prices. It also happened much faster than expected. GDP has dropped 8.2% annualized, matching the decline of 8.2% in the adverse scenario. Unemployment has so far peaked at  13.7% in May, pushing over a point higher than the target. He also points out since unemployment was 5.5% in January, this is an increase of 8.2% percentage points trough-to-peak. Adding, the situation is “exceeding the worst-case scenario.”

Everything but real estate prices have dropped, but as MacBeth highlights – this recession is still fresh. According to CREA, real estate prices have actually increased 2.38% since March. The increase adds to the detachment of fundamentals, with prices rising as the economy gets worse. Most risk firms don’t expect real estate prices to fall until the end of year, or well into the new year. As the banking system returns to normal, and mortgage deferrals begin to expire.

The size of decline is unlikely across the board from the current perspective, however it’s not ridiculous for some segments. Toronto condo prices are only down 1.4% since the peak. A substantial decline would need a lot more negative indicators to climb. However, Calgary and Edmonton condo prices are down a whopping 17.36% and 30.71% from their peak prices, respectively. Had you told someone at the top of those markets that real estate prices could drop, even if oil consumption increases – they probably would have laughed in your face.

Sudden shifts in economic environments can and do happen, and sometimes they breach your worst case scenario. Outlying scenarios are tested for because they are possible and do happen. A rapid deterioration of a market only happens when people don’t expect it, otherwise they could have planned to avoid it.

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  • Adam 4 years ago

    Real estate board numbers are a crock. Vancouver luxury is down at least 20%, probably closer to 30%.

    • Rob Turner 4 years ago

      The increase in prices is due to the rising floor. No more left cheap homes, and luxury is getting cheaper. It’s a stupid way to organize housing. We need real definitions for “luxury” and “starter” to help with the math.

  • Rick Hyne 4 years ago

    I’ve been hearing that home prices are rising as more people move from condos following being locked in a box for a few months, family in hand to a place with a front door and a patch of grass. They can currently now work from their new home. Calculate a reduction in travel expenses and additional time at home from the lack of a commute, not having to buy lunches and other employment costs and the willing to risk of a higher mortgage is a risk many will take.

    However, being over extended as a remote worker is not a good place to be and foreclosures may be with us for some time to come.

    • Winnie The Pooh 4 years ago

      Designed to fail. High income people are working remote, and not going back to the office. They boosted prices to the point there’s very little incentive to live in the city. Save some cash.

      Fly to Montreal on the weekend, where real estate is still cheap enough people can try to start small, hip restaurants and shops. Vancouver is done.

  • Trader Jim 4 years ago

    Bank of Canada’s rate suppression was probably the dumbest thing it did. They incentivized leaving city cores, and accelerated the work from home movement.

    Markets self regulate. When you raise home prices without boosting salaries, you cause permanent damage to cities. People were *waiting* to abandon office towers, and the spin off activity they provide.

    • Rick Hyne 4 years ago

      The next shift will be employers moving to contract workers located around the globe.

      • Michael 4 years ago

        I’m trying to do exactly that right now (as a hiring manager).

        • Rick Hyne 4 years ago

          How many current staff will that affect?

        • Average Man 4 years ago

          Bold of you to admit being part of the problem in public. Way to stab your fellow Canadians and workers in the back.

          • Vovan 4 years ago

            its a business nothing personal, nobody will take a loss so you can make money

          • James 4 years ago

            To be honest, I found North American work force to be a lot more entitled and a lot less accountable than their global counterparts.

          • Jamie 4 years ago

            Just business efficiency. Moving around work to a less entitled and more efficient workforce.

      • alvi 4 years ago

        Or eliminated the job through technology and automaton
        Or paying employee who work from home less

        • Average Man 4 years ago

          It’s personal to the people you lay off. You’re vultures.

          • James 4 years ago

            Travel more to see how the world operates. And may be also read a little more. Darwin’s theory of evolution would be a good start.

    • Steve M 4 years ago

      Bank of Canada has no choice in rates.

      • Quon 4 years ago

        Discount rates, QE, CMBs. Holy crap, is that statement incorrect.

  • Quincy Legere 4 years ago

    Shopify abandoning it’s 1,000 person office in Ottawa 6 years before the lease is up. Cities will be back, but not until it’s affordable for small businesses to start something unique.

    • C.D.R. 4 years ago

      If real estate prices, rents/leases drop to 1/2 where they are currently, we wouldn’t be a country of house poor indebted citizens working paycheck to paycheck.

      Personal consumption spending would be healthier based on income, and not borrowed debt leveraged to another debt, which still has to be repaid.

  • GLM 4 years ago

    When Canada gets its second wave of covid. Which is guaranteed its GAME OVER!!!!

    • JohnyBgood 4 years ago

      Schools will be open for 1 – 2 months max before they shut them down again. This thing is going to spread through travel both inter-provincially and internationally. I wouldn’t be surprised to see a 2nd shut down. All bets are off if this happens.

  • T 4 years ago

    let’s see what comes next let’s just be ready for the outcomes; I personally think the home value will increase in the future as long as banks keep the interest rate low is the key factor.

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