Too In Debt To Fail? Bank of Canada Warns Real Estate May Pause Rate Hikes

Canada’s real estate bubble may force the country’s central bank to put inflation on the back burner. Yesterday, Bank of Canada (BoC) Deputy Governor Tony Gravelle addressed Quebec economists. In his speech, titled the Perfect Storm, he explained various interest rate scenarios. The one that stood out most was pausing interest rates due to housing debt.

Bank of Canada Neutral Rate

Before we start, you need to know what the neutral policy rate is. It’s the range for the key interest rate, where monetary policy has a minimal influence on the economy. In Canada, this range is for the overnight rate. Above the range, the central bank is trying to cool the market and slow inflation. Below the range, they’re trying to raise inflation via stimulus. Until a central bank hits neutral, it’s unclear what the natural level of demand for goods and services is.

Last month, the BoC raised its forecast for the neutral rate to a range of 2% and 3%, a 0.25 point increase. Most economists see the BoC increasing the overnight rate to 2% by this summer. Yes, the current rate is still at a level that contributes to inflation. That’s why they made the biggest rate hike since 2000, and are expected to do it again at the next two meetings. 

Canadian Real Estate May Cause The BoC To “Pause” At Neutral

Earlier this week, RBC warned the BoC might pause rate hikes once they reach the neutral policy rate. They’ll reassess the situation, and then decide if they’ll need to continue higher. Yesterday, the Deputy Governor confirmed that was the plan. Various reasons could impact whether they’ll pause or go past the neutral range. However, the one that stands out is housing — it’s become such a big bubble it may now weigh on the whole economy. 

Before we dive in, it’s worth emphasizing again that pausing at the neutral rate is not pausing now. That would still involve double the current overnight rate. It wouldn’t just be higher than when 2020 started, but the highest since the Great Recession. They won’t be providing housing stimulus. However, they are warning they may put inflation on the back burner due to housing debt.

Bank of Canada May Pause Rate Hikes Due To Housing Debt

Housing is one of the main reasons they might pause interest rates at the neutral point. They reminded Canadians how indebted households have made themselves to get into the housing market. At the end of 2021, the debt-to-income ratio was 186%, above the pre-2020 high of 181%. The central bank explained, this will make households more sensitive to interest rates.

“[A factor that] …might lead us to pause is that many households have taken on more debt to get into the housing market,” said Gravelle.

“… rising interest rates are designed to slow the economy by making borrowing more expensive. That tends to slow sectors like housing. But this slowing might be amplified this time around because highly indebted households will face high debt-servicing costs and will likely reduce household spending more than they would have otherwise. Our base-case scenario includes a slowdown in housing activity. But we could see a larger-than-expected slowdown due to higher indebtedness and unsustainably high housing prices.”

In other words, they may tolerate higher inflation if the housing market is in the dumps. It’s an odd take considering the details of the mortgage debt they didn’t share.

Canada’s Real Estate Leverage Is Concentrated In A Small Share of Consumers

Canadians are highly indebted but not as vulnerable as policymakers present. OSFI Guideline B-20 stress tested borrowers for this exact scenario. Borrowers can withstand at least a 2 point hike in their mortgage rate and still only be at a third of their income. This was prudential planning that began back in 2017, so borrowers are prepared. Unless the BoC knows something about the stress test the public doesn’t, it’s a nothing burger. 

The debt numbers do sound big and scary, but how many people are we talking about? TransUnion data shows only 29.48% of Canadians with credit accounts have a mortgage. There’s a lot of debt, but it’s concentrated in less than a third of households. The bank regulator previously explained a significant percentage of borrowers are overleveraged.

Mom and pop bought too much house, eh? Remember, the poor don’t have much access to debt. We like to think highly indebted people wear barrels with straps for clothes. In reality, it’s wealthy households that have significant leverage. Asset-rich, income “poor” buyers purchasing investment properties are likely a big share. A billionaire with a $1 salary would have a significant debt to income ratio. So would a retiree using their HELOC to pay off an investment property.

Let’s not downplay the debt issues in Canada — people will borrow obscene amounts of leverage to buy a home. Or two… or 16. But the distribution of this debt makes more sense than using it as a national warning. If it’s not an issue that impacts most homes, using a broad tool like monetary policy makes little sense. Regulatory or political tools are much better options. It’s the same reason you kill a fly with a swatter and not a bazooka — to avoid the collateral damage of solving a small issue.

Canada’s Mortgage Borrowers Aren’t As Vulnerable As Presented

Households will see their payments rise but how much are they paying, anyway? We see high home prices and fail to realize most homes were bought before prices surged. According to TransUnion data, the average mortgage payment in Q4 2021 was just $1,380/month. It’s lower than the average rent for a 1-bedroom across Canada. Borrowers are also paying less interest than inflation, which is a gift. Somehow taking away that gift is considered a punishment.

If a household also can’t handle higher payments, they still have options. Extending the amortization is a very common one, even as rates were falling. 

“But what about the recent homebuyers?,” is what every real estate salesperson wants to yell. Since 2021, about 44% of mortgage debt at institutional lenders was issued. Less would have been issued if rates climbed last year when they were supposed to, but that’s another post.

A third of the new debt issued was locked in at fixed rate terms of 5-years or longer. They are locked in at  record low rates, and won’t be impacted for years. OSFI’s B-20 stress test vetted the rest, but let’s say they’re the only ones vulnerable. That’s only a third of all mortgage debt outstanding. These are BoC data points, so it’s surprising they wouldn’t know this and present the data.

Putting it all together, the fact the central bank would consider a pause just due to housing is wild. A pause due to ~9% of mortgage borrowers potentially seeing a third of their income impacted. It’s also likely less, since a third of buyers in pricey markets like Ontario are deep pocketed investors. To save these folks, Canada is willing to embrace more price instability and see the decay of 100% of the population’s money? Good grief.

30 Comments

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  • Woolsock 3 months ago

    What the?!

    I’m no economist but this just seems like the proverbial trolley problem, only the more you look at it the easier it is to choose who gets hit: the super-leveraged. They took the risk.

    Worrying about and pandering to a small group that’s hella leveraged isn’t benign neglect, it’s just unimportant dithering. Trying to save this group sacrifices future growth and accessibility. Hit them and be done with it.

    • Freddy 3 months ago

      Exactly
      I seems to me that they want to destroy the entire economy of the whole country, just to save a few over-leveraged speculators.

      Is it tax-payers responsibility to ensure real-estate flippers make a profit?

      • J 3 months ago

        Magic 8 ball >>> All arrows point to YES. Firing the idiot and replacing him with another idiot won’t change things. Policy and regulation and transparency will fix the problem for future generations. As a 80’s baby – we’re just stuck with a shitty bucket of shit.

      • justsayin 3 months ago

        Remember there are many in the political class that own investment properties as well. Maybe that’s who they are really trying to protect?

    • YC 3 months ago

      I absolutely agree that the Governor of BoC should be fired.

    • Angus Elliott 3 months ago

      The pause would not protect borrowers, it would protect the banks. If the market falls ten percent banks start being exposed to negative equity. They are terrified of folks mailing them the keys.

    • Kris 3 months ago

      Glad we gave away all the money when that flu bug hit. Morons. Print too much money, money becomes useless . Who would have thunk.

  • Quantitative diseased 3 months ago

    This makes me incredibly enraged. Take to the streets enraged. Enough.

  • AB 3 months ago

    Disgusting. They didn’t take the out of control housing market into account while they left rates low but now they can’t raise them because of it?

  • expat 3 months ago

    Reminds me of Alan Greenspan’s legacy. It will all be fine! Until it’s not.

  • Jimmy 3 months ago

    Just the way I see it: like stocks before they plummet full steam ahead, I believe this “pull back” if you want to call it that, is to allow a few to pull out before everything tanks.

    Tumble, tumble, stop, gain, hard tumble, tumble, tumble, tumble…

  • alex 3 months ago

    Translation: We have to say something to soothe the real estate lobbyists who are in our faces for doing our job but we’re still going to front-run the Fed otherwise it’s gg for the looney.

  • Fred Ziffle 3 months ago

    Print more money plz….free money is good…the bubble needs to expand infinitly…bring it on can not wait…leverage not savings is wealth

  • Michelle 3 months ago

    Stress test is imaginary.
    1. People buy a house then spend what they make. So they may have bought a second car or borrowed to take a vacation, or had a child. Now their mortgage comes open and the imaginary cushion is not there.
    2. If the stress test was 2 per cent and rates go up by 3 per cent, the cushion is gone.
    3. If one third of the population has mortgages, can the real estate market absorb these defaults?

  • Miff Tacklem 3 months ago

    They can’t “pause”. If the U.S. Fed continue hiking rates the BoC has to do it as well. If they break ranks with the Fed, the Canadian dollar will suffer greatly, causing more inflation. It’s all smoke and mirrors to make it seem like the BoC cares about the over leveraged.

    • questions guy 3 months ago

      this. 100%

      also, their point may be that there are so many overleveraged people that the RE crash cluld break the economy sooner than expected, hence slowed rate rises

  • Arthur 3 months ago

    Too In Debt To Fail? Bank of Canada Leadership has of course failed – time for a new Board of Governors.
    Extending a losing strategy will do what exactly for Canadians and the economy? Current BofC management must now surely know what inappropriate rate policy does without an offsetting Government Housing Plan. More exuberance is not a PLAN – BofC please forget thinking you are independent and start working with governments, industry groups, real economists and give up on the idea that you can fix this disaster on your own!

  • Devin 3 months ago

    No sympathy left. Raise the rates to 20% and bankrupt all those who are over leveraged. This whole disaster is hurting everyone but the over leveraged. Absolutely absurd.

  • Mark Bayly 3 months ago

    Inflation is too high for the liberals too ignore it It’s running at 15 per cent or more Government inflation numbers are just BS of course House prices are far too high need to come down Don’t people realize if you have hyper inflation your money becomes worthless and that’s where we are heading.

  • Domenic Manchisi 3 months ago

    We need a true leader like Pierre Poilievre

  • RainCityRyan 3 months ago

    For places like GVRD the rates are already too high. Even if the BoC paused, incurred the CAD/USD tumble (good for exports bad for inflation) and held, it’d be happening at too high a rate.

    Finally it doesn’t really matter. If the FED keeps tightening it’ll influence the mortgage rate you can get here (and not making it cheaper).

  • Peter99 3 months ago

    In addition to the terrible unfairness of the idea lies a terrible moral hazard for the next time round

  • Frank Bravo 3 months ago

    Lose-lose. If interest rates dont rise, inflation will lead to job losses, and that will effect all mortgage holders, not just the over leveraged.

  • JM 3 months ago

    … Basically the only thing I’ll agree with Polievre on — Fire the entire BoC staff… or make them do their job.
    This (listening to Trudeau, who’s clearly overleveraged himself) is not it. As is the sentiment above, screw the overleveredged, — they did it to themselves. The entire country needs a housing adjustment. Raising rates would be just the start.
    The BoC is OBLIGATED to raise rates to control inflation. It’s their PRIMARY mandate. NOT TO DO SO would mean there is severe problems/potential political interference over there. PERIOD.

  • Km 3 months ago

    Good to know the writer did some editing as to the whole speech to add the fear monger bait. Do better, you are supposed to be a journalist.

  • Gromit 3 months ago

    It also creates a moral hazard whereby risk takers are insulated from the consequences of their actions and those consequences are passed onto those who did not undertake such risks.

  • R.Froos 3 months ago

    Remember that the Government also has a f$#@ ton of debt and raising interest rates affects them as well.

    • Joe 3 months ago

      They also have a shit tone of benefits and wages to payout and with inflation that increases.

  • Bob 3 months ago

    Decreasing property values and increasing interest rates is a perfect storm for many Self-employed individuals.
    During the COVID lock downs many Self-employed clients had to qualify for ‘Alt-A’ mortgages that would allow their GDS/TDS ratios to go up to 50% as any COVID loans were included with debt payments and any COVID relief was not income. It killed the traditional 2yr average taxable income, so they moved into ‘Alt-A’ programs. Those mortgage terms are typically 1 & 2 yr terms and many of them were offered @ 2.89% . Fast forward to a year from now when these mortgages come to maturity. Those same Self-employed individuals will be facing interest rates at or over 4.99% and if the economy doesn’t pick up for them, many will be unable to move over into a more traditional discounted mortgage at renewal.
    As a mortgage broker, I am concerned…

  • bob 3 months ago

    We need to control inflation, and keep the economy healthy… (In that order) Interest rates are secondary and should fall in line if the other two are looked after. So the BoC has to earn their keep as it’s not going to be easy given much of the inflation is not a result of traditional consumer driven demand.

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