Bank of Canada sees elevated housing-crash risks as debt climbs

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The risk of a sharp correction in home prices is “elevated,” Bank of Canada policy makers said Tuesday from Ottawa in their semi-annual Financial System Review, leaving the rating unchanged from the June report. The central bank uses five grades of risk ranging from low to very high, with elevated being in the middle.

High debt levels among younger families with fewer assets are increasing the danger of housing imbalances, the report said. The report reiterated Governor Stephen Poloz’s view the risk of a crash is low and should be avoidable short of a severe recession and major job losses.

“Housing activity should stabilize in line with economic growth, as the driver of growth in the economy switches from household spending to non-resource exports,” Poloz said in a press release, which will be followed by a press conference at 11:45 a.m.

“Certain vulnerabilities are still edging higher, but recent changes by Canadian authorities to the rules for mortgage financing will help to mitigate these risks as we move into 2016,” Poloz said. The rule changes refer to Finance Minister Bill Morneau’s move on Friday to raise mortgage down payment requirements on homes worth between C$500,000 and C$1 million.

The central bank removed a previous estimate of 10 percent to 30 percent overvaluation in housing prices.

The other elevated risk remains disruptions from a slump in China and other emerging markets. Policy makers also said there is a moderate risk of a jump in the yields demanded by global bond investors.

There are signs that Canada’s total household debt burden may also be dangerous. The share of indebted households with obligations exceeding 350 percent of gross income has climbed to 8 percent from 4 percent before the global crisis, the Bank said. Debt at that level raises the risk of a failure to pay the lender back.

Apart from risks, the Financial System Review lays out “vulnerabilities” and said there’s a high and rising level of household indebtedness.
Poloz last week outlined rules that could allow him offer more stimulus if the economy faces another shock, saying he doesn’t expect to need them. Those tools include the ability to take his policy interest rate to negative 0.5 percent, major asset purchases known as quantitative easing, or so-called forward guidance on future interest rates. Poloz said his main aim in making that announcement was to update policies that were first laid out during the global financial crisis and never used.

Such changes in the bond market since the global financial crisis add one other vulnerability for Canada the bank said today: the risk of a freezing up of fixed-income markets with more debt being perceived as harder to trade.

The risks in housing and the global economy underscore the tension behind Governor Stephen Poloz’s two interest-rate cuts to 0.5 percent this year, aimed at reviving the world’s 11th largest economy from a drop in oil prices.

Most of the housing-market risk appears to be concentrated in Toronto and Vancouver, where single-family detached dwelling prices have surged beyond C$1 million. Home prices have fallen this year in the Alberta cities of Calgary and Edmonton being hit by the drop in crude oil prices, and gains have been more modest in most other parts of Canada.

Canadian household debt ascended to another record in the third quarter, underscoring why policy makers are stepping up efforts to limit the risks of a collapse in the nation’s real estate market. Credit-market debt including mortgages was 163.7 percent of after-tax income, up by 1 percentage point from the second quarter, Statistics Canada said Monday in Ottawa.

The divide between a hot housing market and weakness elsewhere may continue, with crude oil falling to $35 a barrel this week and Canada’s last trade deficit of C$2.76 billion in October wider than any economist had forecast. Encana Corp. on Monday cut its dividend by 79 percent and reduced spending and production plans for 2016.

Bloomberg News
Greg Quinn

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