The governor of the Bank of Canada warned Thursday that the high level of household debt in the country will be a “vulnerability” if the economy slows and house prices see a steeper decline than first thought.
Speaking to the Public Policy Forum in Toronto, Tiff Macklem was asked whether the central bank’s campaign to raise interest rates and tackle high inflation will see an outsized impact on the country’s housing sector.
He identified the run-up in home prices over the COVID-19 pandemic and the big mortgages Canadians took out to enter the market over that time as a risk the bank is watching closely.
“If the economy were to slow sharply, that vulnerability could accelerate the downturn,” Macklem said.
“If people lose their jobs, they’re going to have a hard time covering their mortgage and if they have a very big mortgage, if their house price comes down, even selling their house may not cover it. That is a vulnerability.”
The Bank of Canada’s policy rate was at 0.25 per cent for the majority of the pandemic, and many Canadians took the opportunity to enter the housing market with low mortgage rates.
During this period, home prices rose more than 50 per cent and the housing market was “unsustainably hot,” Macklem said Thursday.
Variable-rate mortgages, which respond directly to the central bank’s interest rate decisions, overtook their fixed-rate counterparts as the most popular choice for homebuyers in the second half of 2021.
“More people than usual stretched to get into the market, and one of the ways they did that was with a variable rate mortgage,” he said.
Global News asked Macklem in a press conference after his remarks whether he felt these Canadians understood the risks of rapidly rising interest rates when they took out variable rate mortgages.
“I hope they got good advice from their financial institution. … I am acutely aware that some Canadians took out fairly high ratio mortgages late in that cycle with variable rates and with the rapid increase in rates, their borrowing costs are resetting. And it is a difficult adjustment for them.”
Macklem did identify government policies limiting foreign investment in the housing market and the mortgage stress test, which sees homebuyers and refinancers qualify at higher interest rates as a buffer for increases, as helpful for mitigating these risks.
How high will interest rates go?
The Bank of Canada has raised its benchmark interest rate 3.5 percentage points since March to 3.75 per cent and has signalled it will need to rise further to tamp down inflation.
Macklem was asked Thursday whether the central bank will return to standard quarter-percentage-point steps in the policy rate following numerous oversized hikes in a row.
He said that the Bank of Canada will be watching next week’s Consumer Price Index figures for improvement in the core inflation rate, and will factor into the rate decision any global supply chain developments and the latest employment figures, which last week surprised economists by showing 108,000 new jobs were added in October.
Macklem explained in his speech Thursday that the tight labour market is contributing to inflation, as businesses struggling to find workers can’t keep up with demand for goods and services in the economy.
“The tightness in the labour market is a symptom of the general imbalance between demand and supply that is fueling inflation and hurting all Canadians,” he said, adding that the labour market will have to cool before the inflation fight is settled.
Some sectors, such as construction and manufacturing, are showing signs of slowing in the face of higher interest rates, Macklem noted. But he also said the unemployment rate likely won’t need to rise as much as it has in previous recessions.
Macklem highlighted that the central bank’s increases have steadily eased from 100 basis points in July to 75 and 50 basis points in each subsequent decision, and said another step down could be in the cards depending on the inflation data.
“I think that could be another bigger than normal step or it could be reverting to a more normal 25-basis-point step,” he said.
— With files from The Canadian Press
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