Bloated debt loads, high home prices risks to Canada’s economy

Canadian home prices have reached 'lofty' valuations, according to a new report from debt rating agency Moody's.
Homes sales in the city dropped 12.1 per cent in August compared to the same month in 2013. AP Photo/Wilmington Star-News, Ken Blevins, File

The latest monthly retail sales figures, or total amount Canadians spend on shopping, will be released on Wednesday. The data is likely to show consumers taking a breather on spending activity, according to experts.

But that’s probably a good thing considering the latest warning over bloated debt levels issued on Monday.

Canadian consumers have continued to spend beyond their means this year, even as income gains and access to credit have slowed down. That’s left our booming housing market as the principal driver of confidence to go out and continue spending, according to Moody’s Investor Service.

“The wealth effect stemming from the real estate market now appears to be the main driving force behind robust consumer spending,” the ratings agency said in a new note on Monday.

Moody’s said home prices in the country’s 11 largest centres accelerated year-on-year in September, aided by rock-bottom interest rates, creating “lofty housing valuations” or prices.

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“While Canada’s peers [like Australia] have also seen similar trends in recent years, Canada’s market … appears to be particularly inflated, especially in the largest metropolitan areas,” the report said.

MORE: Canada’s housing boom comes down to just 3 cities

The frothy market presents a “downside risk” to Moody’s outlook for the Canadian economy, which the agency says remains good so long as a major shock doesn’t exert itself on households – like a crash in oil prices or spike in interest rates.

Scenario A or B

A likely scenario Moody’s says is for borrowing rates to gradually rise over the medium term, or “normalize” in the “coming years,” something that could chill consumer spending as borrowing becomes more costly.

Rising rates would suck momentum out of home buying and real estate prices, and the wealth effect now powering consumer confidence would dissipate.

Absent a “meaningful pickup” in jobs or wage pressure, the economy will settle into a chilly period. Yet the impact will be “moderate,” the report said, especially if conditions within the U.S. economy continue to improve lifting Canada’s fortunes in the process.

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“Alternatively, the housing market may correct in response to a macroeconomic shock,” Moody’s analysts Steve Hess and Anne Van Praagh said – a much more damaging scenario that could lead to big declines in home prices as confidence in the market declines sharply.

The Bank of Canada as well as federal officials have said throughout the year they see no bubble forming in the housing market and that it is positioned to land softly – where prices flatten out or rise modestly — after a decade-long boom.

As housing prices have continued to rise in some centres, some analysts disagree with the assessment.

“With no signs of a soft landing for the housing market in sight, we believe that the increased vulnerability presents the largest downside risk” to Canada’s economy over the medium term, Moody’s said.

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