Low interest rates may shield Canada's housing market from a bubble, economists say.Fred Lum/The Globe and Mail
Fitch Ratings thinks that Canadian home prices will manage to stay flat or dip just a little bit this year, despite its belief that they are 20 per cent too high, because of the strength in the housing market.
The expected decline in the pace of home price growth, coupled with high consumer debts, will likely lead to a rise in mortgage delinquencies, although they will remain at relatively low levels, the rating agency added.
Fitch has been saying for roughly a year that it believes Canadian home prices are overvalued to the tune of 20 per cent. But in a report released Tuesday it suggested that it does not forecast much trouble for the market in 2014, saying that a "correction [is] not yet in sight" for Canada and a number of other countries that it has been concerned about.
While most economists agree that Canadian home prices are currently too high, estimates of the overvaluation range from 5 or 8 per cent to 60 per cent. Policy-makers here are hoping that employment and incomes will rise while home prices flatten out, helping the situation to sort itself out without any sharp drop in prices. But if the housing market keeps up its momentum – which is fuelled in large part by low interest rates – risks will continue to build up in the system. The market staged a surprisingly strong rebound in the middle of 2013, but recently has shown signs that the momentum is petering out: the number of existing homes that changed hands has slipped down month-to-month for three months in a row.
While Fitch expects rising economic growth and supportive government policies to boost mortgage lending in most countries this year, it sees lending volumes softening in Canada because of measures Ottawa has been taking to curb the housing market.
"The Canadian government is exerting a moderating influence on the market, following concerns over the long-term viability of household debt levels and high prices," it said in the report. "This should lead to muted lending in 2014/15."
The Canadian Association of Accredited Mortgage Professionals forecasts that mortgage credit will rise by 3.25 per cent this year and by 3 per cent in 2015, compared to an average rate of 8.6 per cent during the past decade. That would bring the total amount of residential mortgage debt that Canadians have outstanding to about $1.29-trillion by the end of 2015.
"While Canadian prices may fall this year, Fitch believes any decline would be slight due to the country's strong macro-economic trends and cautious lending policies driven by government measures, which are expected to slow lending in 2014," the rating agency said in its report.
But it added that affordability "is already very stretched" despite record low interest rates, and that if the Bank of Canada raises interest rates later this year that will put additional stress on the market.
While many economists don't expect the central bank to raise rates until the middle of 2015 or even later, Fitch says it expects them to go up towards the end of 2014.
"Fitch expects mortgage rates to remain mostly steady initially in 2014, though there is likely going to be more upward pressure nearing the end of the year from both U.S. policy and Canada's internal government," it said.
Mortgage prices tend to follow changes in five-year government bond yields (because those impact the price that banks pay to obtain money to lend out), and Canadian bond yields tend to follow U.S. bond yields, meaning that Canadian mortgage rates depend in large part on the outlook for the U.S. economy.
Royal Bank of Canada, this country's largest mortgage lender, cut a number of its fixed mortgage rates by 10 basis points this past weekend. Lenders such as Home Trust and First National Financial LP have also decreased their rates this month.
"Primarily due to rising home prices, household debt-to-disposable income ratios have risen dramatically over the past decade, despite a large drop in mortgage rates over the same period," Fitch noted.
It expects the ratios to stabilize this year as home price growth slows or reverses. "Nearing the end of 2014, there may be increased risks of rising debt ratios given pressure from rising interest rates," it said.