The country’s central bank remains worried about rising debt levels among Canadian consumers – a trend that’s developing into a major vulnerability to the economy as households borrow more and more money without the wage gains to back it up.
Much of that debt is being funnelled into the housing market, which has experienced runaway price growth in some regions in recent years, notably Vancouver and Toronto.
That’s led the Bank of Canada to reiterate on Wednesday its concern that chances of a nasty correction are rising.
“Vulnerabilities in the household sector are continuing to edge higher,” the bank said in a new report on the economy. Historically low mortgage rates are contributing to “strong growth in mortgage credit, especially in British Columbia and Ontario.”
“Although the most likely scenario is one in which these imbalances unwind gradually as the economy improves, a disorderly unwinding, such as one that might be triggered by further weakness in the resource sector or a rapid rise in global interest rates, could have sizable negative effects.”
Good news, bad news
The good news: the country has largely rebounded from a mild recession brought about by lower oil prices earlier this year, according to the bank, and the job market is proving surprisingly resilient, experts say.
The less-than-good news: consumer borrowing is fuelling the rebound (which has been “supported by the stimulative effects” of the Bank of Canada’s two rate cuts this year, in January and July), the bank said.
“Household spending continues to underpin economic activity,” the bank noted.
Low rates aren’t just encouraging home buyers – they’re encouraging car buyers, furniture buyers, and others as debt in all forms grows. The bank’s report said increased borrowing continues to easily outpace gains in take-home pay. That means Canadian households are digging themselves deeper and deeper into debt.
Why rates are low
As part of its mandate to keep the financial system and economy stable, the Bank of Canada sets its key, overnight lending rate it provides private lenders such as big banks, who in turn use the key rate to determine the interest rates they charge customers.
The central bank has dropped rates to record low levels in recent years to help the economy recover from the Great Recession — and most recently to boost growth amid the the oil crash. But in so doing, it has fuelled bulging debt levels among consumers.
By the bank’s own estimate as many as 1.5 million households have taken on risky levels of debt.
The bank expects incomes to catch up as the economy begins to improve next year and interest rates “normalize,” or head back up to levels associated with a Canadian economy operating closer to full capacity (see chart above, before 2009).
“Looking ahead, the housing market and household indebtedness are expected to stabilize over the projection period as the economy gains strength and household borrowing rates begin to normalize.”
Still, the country’s central bank remains cognizant that growth is coming at the expense of higher household debt levels – and that’s creating something of a ticking time bomb, which economy watchers aren’t sure can be easily diffused.
“Persistent strength in household spending would provide a near-term boost to economic activity, but it would also further exacerbate existing imbalances in the household sector, increasing the likelihood and potential severity of a correction later on,” the bank said.