Canada needs ‘pain’ for lower housing prices and economic stability: Bank of Canada

Canada needs ‘pain’ for lower housing prices and economic stability: Bank of Canada

Canada has ninety nine problems and mortgage debt… More than two trillion of them. Bank of Canada (BoC) Governor General Carolyn Rogers addressed concerns about financial stability earlier today. He boiled it down to two major concerns that have been around for a long time, but are growing: home debt and housing. He warned that the coming months could be painful for home owners, but it is necessary to restore balance in the country’s markets.

Canada’s financial stability threatened by house prices and debt

The BoC senior deputy governor focused on two specific areas that present financial stability: household debt and house prices. They emphasized that neither problem is new, and central bank reports have mentioned these issues up to 2006. The absence of a disaster so far does not mean that it is not a concern, but quite the opposite—weakness is building in the system. . What might have been a small problem in 2006 is a very big problem now, as housing consumed the Canadian economy.

Rogers explained that before the pandemic there were significant concerns about affordability and investor speculation. When the pandemic hit, the problems that existed primarily between Toronto and Vancouver spread across the country.

“In less than two years, housing prices rose by more than 50% in most markets. And the housing activity – the number of houses bought and sold – was about 30% higher than the level before the pandemic”, he emphasized.

An important point, because this was not the period of weak activity that the low rates wanted to stimulate. Low rates spurred stronger-than-normal activity, and the market continued to step on the gas with more stimulus.

Increases in preload rates will reduce how high rates go

Pumping the gas while the economy is growing is the easiest way to ensure that inflation rises. We had high inflation before the invasion of Ukraine, which sent it into the stratosphere. Moving slowly the crisis escalated, forcing the need for immediate action.

“We’ve raised interest rates quickly because history tells us that a front-end rate hike gives us the best chance to cool the economy quickly and keep inflation expectations anchored. This avoids the possibility of more hikes down the road,” he explained.

Although he did not elaborate on this point, it is textbook monetary policy. The slower rates rise in an attempt to cool excess demand, the greater the risk of interest costs feeding into inflation. It creates something called an “inflationary spiral”, where inflation and measures to mitigate it create a cycle that is difficult to break.

“We have a long way to go to get inflation back to target, but there are some early signs that monetary policy is working. Unfortunately, this adjustment is not painless. We recognize that,” he warned.

Canadian housing prices must fall to restore balance

Homeowners across Canada have faced the consequences of this, especially those who have been inclined to think rates will stay low for longer. He indicated that not a large part of the houses, but more than usual have opted for variable rate mortgages. Those buyers are now paying higher rates than expected, and interest has swallowed up most of the payments. Fixed-rate borrowers aren’t immediately affected by higher rates, but will face higher costs when they renew. In short, homeowners will soon be paying a lot more.

At the same time, the excess credit that helped drive up investor demand and house prices has led to a toxic market. Back to square one, homebuyers were already facing a lack of affordability with house prices rising by 50%. Not just in Toronto or Vancouver, but across the country. Technically, house prices will have to fall, and surprisingly that’s what the BoC said today.

“We need lower house prices to restore balance to Canada’s housing market and make home ownership more affordable for more Canadians,” said the lieutenant governor. Adding, “But low home prices can cause stress for people who have recently bought. They will reduce their equity, which can limit their refinancing options.”

Short-term end-users are likely to suffer the least, as they won’t be leaving their position for years. However, investors who hold very short positions may have immediate liquidity concerns. Especially if they are in the pre-sale segment and have not yet taken possession of the property they have committed to buying.

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