Money is a limited resource. There is a reason why the Bank of Canada oversees the country’s monetary policy. If there’s enough liquidity in the market, people and businesses tend to borrow. Increased borrowing translates into spending and the resulting debt may turn into a long-term liability.
In the midst of a pandemic that has ravaged not only the Canadian economy but every developed and emerging market, the domestic housing sector seems to be swimming against the tide. It is creating wealth for sellers even as other sectors of the economy grapple, leading to a high unemployment rate of 8.2 per cent.
Behind this housing market growth, sometimes termed hyperinflation, is easy and cheap debt available to Canadians. For over a year now, the central bank has kept policy interest rates at a record low and despite inflationary pressures, any immediate hike is out of sight.
Another critical factor is the high household savings owing to wage subsidy and other allowances doled out by the federal government. This pandemic stimulus was, however, never intended to fire up the housing market. It was meant to boost demand across sectors because subdued demand can push the economy into depression, besides dealing a body blow to job creation.
According to Equifax, a multinational credit reporting agency, the credit card debt of Canadians is at a six-year low. However, mortgage debt is rising fast, accounting for a large chunk of total household debt. British Columbia and Ontario, which have the hottest housing markets, have seen the biggest hike in consumer debt, as per the agency.
The situation is perplexing. Credit card debt, which customarily should have surged given joblessness and inflation, is down and mortgage debt, which essentially translates into a bigger chunk of income going toward repayment, is up.
CREA confirms average house price in Canada surged by 38 per cent year-over-year in May 2021, despite moderating house prices over the past two months. Clearly, people are bidding more to acquire a new house, which has squeezed out groups like new Canadians, youth and single parents. Many of them will be renting spaces acquired at high prices, leading to increased rental payouts that can hurt this group and curb their spending capacity on other goods.
Central bank warns of high mortgage debt
Less than a month ago, the Bank of Canada warned about the damage soaring house prices can cause to the broader economy. Firstly, since mortgage debt is offered at a variable rate, servicing debt can become costly once the central bank decides to hike benchmark rates. Secondly, mortgage debt curtails the spending capacity of households by a significant margin.
Tiff Macklem, governor of the central bank, has categorically termed imbalances in the housing sector as the “biggest domestic vulnerabilities”. Wealth has been parked in housing assets, inadvertently leading to a sizeable drop in household consumption.
The central bank said Canadian households are “loaded with mortgage debt”, a fact now corroborated by the latest Equifax report. The pandemic has yet to subside and the economy is yet to attain pre-pandemic employment and international trade fronts.
The biggest worry is that the twin elements of government subsidy and cheap credit fueling housing sector growth are anything but eternal. Cash support has already shot up the debt-to-GDP ratio, and to reign in fiscal slippages, the government can withdraw such measures anytime. The central bank also has limited elbow room to keep interest rates at near-zero levels in the wake of rising prices. In April, inflation surged by 3.4 per cent, the highest pace in almost a decade. The bank has said that the April price rise will not require “immediate action”; however, a rate hike cannot be ruled out in the medium term.
Marginal cooling down of the searing housing market over the past two months hints at some ongoing correction. If the Bank of Canada’s warning is anything to go by, the decline in household income will be coupled with a fall in housing prices. Any event like a stock market crash or hike in benchmark rates can lead to sharp repricing of mortgage debt exposure, the bank says. Higher debt servicing cost and reduced credit availability can bring down housing prices, something that recent stress tests failed to do.
Money is a limited resource and high inflation can further limit its supply. The cessation of government cash support will put pressure on household income. It can shape Canada’s housing sector in the medium term. Meanwhile, what is more worrying is the existing burden of mortgage debt on Canadian households.
The silver lining is the reopening of the Canadian economy and improved activity after vaccine rollouts.
Kunal Sawhney is the founder and CEO of Kalkine. An accomplished financial professional, he has extensive expertise in equity markets and adopts quantitative and qualitative stock selection practices.
