The Bank of Canada believes that higher interest rates and stricter mortgage regulations are successfully curbing lofty Canadian home prices and high household debt levels, but warns that the vast size of outstanding debt continues to pose a key risk to the financial system.
“The two main vulnerabilities we have been watching closely are showing continued signs of easing, which is encouraging,” Stephen Poloz, Governor of the Bank of Canada, said in a statement.
The upbeat assessment comes from the Bank of Canada’s semi-annual Financial System Review, released on Thursday, and follows substantial changes to the country’s mortgage regulatory framework and economic conditions in Canada.
Regulators, keen to slow the pace of house price growth in a number of key Canadian markets, especially Toronto and Vancouver, recently tightened mortgage regulations and imposed stress tests to make it more difficult for prospective home buyers to qualify for loans.
Share of new mortgages with loan-to-income
ratios greater than 450 per cent
High-ratio mortgages
Low-ratio mortgages
Total mortgages
25%
November FSR
20
15
10
5
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Share of new mortgages with loan-to-income
ratios greater than 450 per cent
High-ratio mortgages
Low-ratio mortgages
Total mortgages
25%
November FSR
20
15
10
5
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Share of new mortgages with loan-to-income ratios greater than 450 per cent
High-ratio mortgages
Low-ratio mortgages
Total mortgages
25%
November FSR
20
15
10
5
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
At the same time, interest rates and bond yields have been rising with global economic activity, lifting borrowing costs significantly. Five-year fixed mortgage rates have increased by about 110 basis points over the past year, and rates for variable mortgages have risen by nearly 40 basis points – weighing further on household debt levels. (There are 100 basis points in a percentage point.)
Government bond yields
Yields to maturity on five-year sovereign bonds
Canada
U.S.
Germany
Japan
Britain
4.0%
November FSR
3.0
2.0
1.0
0.0
-1.0
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Government bond yields
Yields to maturity on five-year sovereign bonds
Canada
U.S.
Germany
Japan
Britain
4.0%
November FSR
3.0
2.0
1.0
0.0
-1.0
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Government bond yields
Yields to maturity on five-year sovereign bonds
Canada
U.S.
Germany
Japan
Britain
4.0%
November FSR
3.0
2.0
1.0
0.0
-1.0
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
The ratio of Canadian household debt to disposable income was close to 170 per cent at the end of 2017, fueled in part by low borrowing costs and high home prices, which raised concerns among a number of observers within Canada and international institutions. However, the Bank of Canada believes the ratio likely declined slightly in the first quarter of this year, providing some relief.
“Growth in residential mortgages and home equity lines of credit slowed in the first four months of the year, in line with weaker home sales and slower house price growth,” the Bank of Canada noted in its review.
“The pace of other consumer borrowing, which makes up the remaining 15 per cent of outstanding household debt, has also slowed,” it added.
Household credit growth
Residential mortgage credit and home equity lines of credit
percent change, right scale)
Consumer credit, excluding home equity lines of credit
(percent change, right scale)
Level of the debt-to-disposable-income ratio (left scale)
175%
10%
November FSR
8
170
6
165
4
160
2
155
0
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Household credit growth
Residential mortgage credit and home equity lines of credit
percent change, right scale)
Consumer credit, excluding home equity lines of credit
(percent change, right scale)
Level of the debt-to-disposable-income ratio (left scale)
175%
10%
November FSR
8
170
6
165
4
160
2
155
0
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Household credit growth
Residential mortgage credit and home equity lines of credit percent change, right scale)
Consumer credit, excluding home equity lines of credit (percent change, right scale)
Level of the debt-to-disposable-income ratio (left scale)
175%
10%
November FSR
8
170
6
165
4
160
2
155
0
2014
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Yet the Bank of Canada believes that it is still too early to gauge the full impact of tighter mortgage standards, the latest of which kicked in at the start of 2018. Home buyers, faced with new qualification rules in 2018, could have pushed ahead with their borrowing decisions prior to the implementation of the new rules or benefited from preapprovals in the first quarter of this year, clouding the picture so far.
As well, trade tariffs recently imposed by the United States, amid concerns about the prospects of an all-out international trade war, are hanging over the economic outlook this year.
The central bank expects that updated rules to mortgage qualifications alone will weigh on economic activity, but was silent on the potential impact of trade tariffs. The bank estimates that the new rules will subtract about 0.2 percentage points from gross domestic product by the end of 2019.
“Considerable uncertainty around its ultimate impact on economic activity and mortgage quality remains,” the bank said.
The Bank of Canada added that home price growth peaked in early 2017, when rising employment, increased immigration, low interest rates and speculative behavior boosted demand for housing amid a limited supply of new single-family homes in some cities.
Now, though, the year-over-year increase in home prices has declined from 20 per cent in April, 2017, to about 1.5 per cent nationally, driven by price declines in the Greater Toronto Area and declining sales in the Greater Vancouver Area.
Year-over-year growth in quality-adjusted
benchmark house prices
Greater Vancouver Area, Vancouver Island,
Victoria and Fraser Valley
Greater Toronto Area, Barrie and district, Guelph and district
Calgary, Edmonton, Saskatoon and Regina
Ottawa, Montreal and Moncton
Canada
35%
November FSR
30
25
20
15
10
5
0
-5
-10
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Year-over-year growth in quality-adjusted
benchmark house prices
Greater Vancouver Area, Vancouver Island, Victoria and Fraser Valley
Greater Toronto Area, Barrie and district, Guelph and district
Calgary, Edmonton, Saskatoon and Regina
Ottawa, Montreal and Moncton
Canada
35%
November FSR
30
25
20
15
10
5
0
-5
-10
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
Year-over-year growth in quality-adjusted benchmark house prices
Greater Vancouver Area, Vancouver Island, Victoria and Fraser Valley
Greater Toronto Area, Barrie and district, Guelph and district
Calgary, Edmonton, Saskatoon and Regina
Ottawa, Montreal and Moncton
Canada
35%
November FSR
30
25
20
15
10
5
0
-5
-10
2015
2016
2017
2018
THE GLOBE AND MAIL, SOURCE: BANK OF CANADA
While the housing market appears to be heading in the right direction, the Bank of Canada has highlighted cybersecurity as a key vulnerability in Canada’s interconnected financial system – a topical concern given that Bank of Montreal and Simplii Financial, an arm of Canadian Imperial Bank of Commerce, have both revealed potential cyberthreats in recent weeks.
The central bank has been working with the Big Six banks and Payments Canada - which is responsible for much of the country’s payments infrastructure - to make sure the financial system can recover quickly in the event of a successful cyberattack, focusing on the need to share resources and expertise.
“Continued collaboration and a greater pooling of resources are needed to increase the overall resilience of the financial system,” Mr. Poloz said.