MNI: BOC Sees New Peak Coming In Highly Indebted Households

Canada's central bank predicts a new peak in the share of households carrying risky levels of debt after the pandemic triggered another housing boom as people sought more space, and this vulnerability means commercial lenders may face a bigger hit if interest rates surge.

The 2019 peak in households with debt exceeding 3.5 times their income will likely be broken by yearend and top 16%, Deputy Governor Paul Beaudry said in prepared remarks for an Ontario Securities Commission conference. The trend has soured in recent quarters to a "deteriorating quality of new mortgage borrowing" from early in the pandemic when people were paying down debt, he said.

"Vulnerabilities linked to elevated household debt appear to be rising again after a slight pause," Beaudry said.

"A sudden influx of investors in the housing market likely contributed to the rapid price increases we saw earlier this year. In such a case, expectations of future price increases can become self-fulfilling, at least for a while. That can expose the market to a higher chance of a correction," he said.

Home prices in Vancouver and Toronto surged over the past decade and now often cost more than a million dollars, leading to several rounds of tougher mortgage rules and speculation taxes to head off any bubble. International agencies and investors have said Canada's housing market is one of the most overstretched in the world. Domestic officials in recent weeks have said a lack of supply appears to be the major cause of the problem.

CLIMATE CHANGE RISK

"The main financial vulnerabilities that Canada faced before the pandemic -- namely imbalances in the housing market and high household indebtedness -- remain significant. Also, climate change and the transition to a low-carbon economy bring new financial risks that will be increasingly important," Beaudry said.

The BOC and bank regulator OSFI should present a climate risk paper in January. "Scenario analysis by the Bank and others has found that while failing to act limits transition risks at first, it eventually carries a significant economic cost in the form of greater damage to homes, businesses and infrastructure," he said. "Our analysis therefore confirms that if we act now to battle climate change, our financial system should be in a good position to facilitate the transition to a low carbon economy."

House prices in some major markets appear to have risen this year partly on self-fulfilling expectations of further gains, and supply in Montreal, Toronto and Vancouver is "extremely inelastic," Beaudry said.

"None of that is to say a calamity is on the horizon," he said.

RISING INTEREST RATES

Lower interest rates have helped drive the situation and Canadians have ended up taking on bigger mortgages to leave their debt servicing costs unchanged, Beaudry said. Higher prices also mean the share of Canadians owning a home has also been little changed.

"While Canadian banks are resilient, these vulnerabilities could exacerbate the economic impact of any substantial rise in interest rates or adverse shock," Beaudry said. "Interest rates can be expected to rise as the effects of the pandemic dissipate and excess capacity in the economy is fully absorbed."