Canadian Households Are Stable, But Rate Cuts Won’t Offset Downside: BMO

Canadian household debt has been showing big improvements. A combination of rate hikes that slowed borrowing, and recent rate cuts are delivering repayment relief. Before popping that bottle of HELOC-finance champagne, this may be the calm before the storm, warns BMO. Several economic headwinds, primarily the trade war, are set to hit households. The central bank is expected to lower rates to provide some relief, but it won’t be enough to protect households from the downside. 

Canadian Household Debt Showed Major Improvements Recently

Canadian household debt indicators came in much better than most would expect. Higher rates provided a drag on debt accumulation, while robust wage growth took the lead. As a result, the debt-to-income ratio plunged back to 2015 levels. That was just part of the debt improvements, painting a picture of stabilizing household debt. 

“Canadian households’ balance sheets were relatively stable to cap off 2024,” says Shelly Kaushik, senior economist at BMO.  

Adding, “… the debt-to-income ratio ticked up for the first time in almost two years but is down almost 13 ppts from its peak in 2021.” 

There was a minor setback last quarter, with low rates and policy stimulating credit growth. However, it was minor in contrast to the recent improvements observed and helped with another indicator—the debt service ratio (DSR).  

Source: BMO Capital Markets; Haver Analytics; Statistics Canada. 

The DSR is the share of their disposable income dedicated to making minimum payments on credit products. As this ratio falls, it frees up more disposable income for consumption, investing, and other economy-driving activities. 

Emphasizing another stabilizing point, Kaushik notes, “The debt service ratio fell in all four quarters and was sitting just above 14% in Q4, providing relief for household budgets through the year.” 

Canadian Household Debt Improvements Are Mostly Temporary

Debt is effectively using the value of future productivity (and interest) to make a purchase today. In short, it’s borrowing future activity at the expense of dedicating future income to paying off previous economic activity. Lowering rates helps to reduce the DSR, freeing up capital for spending. However, it also incentivizes more borrowing, driving demand and thus inflation and borrowing future growth. That would be counterproductive to the goal, even if it appeases people in the short term. 

Consequently, policymakers considering the country’s long-term stability must walk a fine line. Rates too low for too long can mean higher inflation and debt accumulation. If rates are too high for too long, it becomes restrictive on normal credit-driven activity, and debt accumulation becomes a dangerous liability.  

That said, policymakers are expected to ease rates further in the coming months. Especially if the trade war fails to resolve in an orderly fashion soon. 

Bank of Canada Rate Cuts Won’t Be Enough To Mitigate Downside

How does this shift consumer credit health, and thus the economy via consumption? “The outlook for the coming quarters is much less clear. If, as we expect, the trade war continues to weigh on economic growth, the labor market—and income growth—will take a meaningful hit,” says Kaushik. 

There’s a lot of certainty about cheaper credit on the horizon but not much about its ability to mitigate the headwinds. 

“Further expected easing by the Bank of Canada can cushion some of that impact, but it won’t be enough to offset the downside risks for households,” warns the bank.