Canada’s got ninety-nine problems and mortgage debt is…. Over two trillion of them. Bank of Canada (BoC) senior deputy governor Carolyn Rogers addressed concerns about financial stability earlier today. She boiled it down to two major concerns that have been present for a long time, but are building up — household debt and housing. She warned the coming months can mean some pain for homeowners, but it’s necessary to restore balance to the country’s markets.
Canada’s Financial Stability Threatened By Home Prices & Debt
The BoC senior deputy governor focused on two specific areas that present financial stability — household debt & home prices. They emphasized neither problem is new, and the central bank’s reports have mentioned these issues as far back as 2006. A lack of disaster so far doesn’t mean it’s not a concern, but the exact opposite—the vulnerability is building up in the system. What could have been a minor issue back in 2006 is now a very large issue, as housing consumed Canada’s economy.
Rogers explained there were significant concerns about affordability and investor speculation prior to the pandemic. When the pandemic hit, issues that were primarily between Toronto and Vancouver spilled out across the country.
“Over the course of less than two years house prices went up by more than 50% in most markets. And housing activity—the number of houses being bought and sold—was about 30% higher than pre-pandemic levels,” she emphasized.
An important point, since this wasn’t a period of weak activity that low rates were trying to stimulate. Low rates stimulated activity stronger than normal, and the market kept pumping the gas on more stimulus.
Front Loading Rate Hikes Will Reduce How High Rates Will Go
Pumping the gas while the economy is booming is the easiest way to ensure inflation surges higher. We had significant inflation prior to the invasion of Ukraine, which sent it into the stratosphere. Moving slowly was compounded by a crisis, forcing the need for immediate action.
“We have moved interest rates up quickly because history tells us that front-loading rate increases gives us the best chance to cool the economy quickly and keep inflation expectations anchored. This avoids the prospect of larger increases down the road,” she explained.
Though she didn’t elaborate on this point, it’s textbook monetary policy. The slower rates are hiked when trying to cool excess demand, the higher the risk of interest costs being incorporated into inflation. It results in something called an “inflationary spiral,” where inflation and its attempted mitigation measures create a cycle that’s hard to break.
“We have a long way to go to get inflation back to target, but there are some early signs that monetary policy is working. Unfortunately, this adjustment is not without some pain. We recognize that,” she warned.
Canadian Home Prices Need To Fall To Restore Balance
Canada’s homeowners have been dealing with the fallout of this, especially those misled into thinking rates will be low for longer. Not a large share of households she noted, but more than typical have opted for variable rate mortgages. Those buyers are now paying rates significantly higher than expected, with interest now swallowing most of the payments. Fixed rate borrowers aren’t immediately impacted by higher rates, but they’ll be facing higher costs at renewal. In short, homeowners will pay a lot more soon.
At the same time, the excess credit that helped boost investor demand and home prices has led to a toxic market. Circling back to her initial point, homebuyers were already facing a lack of affordability, compounded by a 50% increase in home prices. Not just in Toronto or Vancouver, but right across the country. Technically, home prices are going to have to come down, and surprisingly that’s what the BoC said today.
“We need lower house prices to restore balance to Canada’s housing market and make home ownership more affordable for more Canadians,” said the deputy governor. Adding, “But lower house prices may add stress for those people who purchased recently. They will have reduced equity, and this may limit their options to refinance.”
Short-term end users are likely to experience the least pain, since they won’t be exiting their position for years. However, the investors that entertained very immediate positions can face immediate liquidity concerns. Especially if they’re in the pre-sale segment, and have yet to actually take hold of any housing they’ve committed to buy.