Bank of Canada Says Housing Price Crash Remains Biggest Risk

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The Bank of Canada said a crash in housing prices that are overvalued by as much as 30 percent remains the biggest risk to the country’s financial system, a danger that has edged higher on the drop in crude oil prices.

The risk the housing market could falter from a drop in employment and consumer income remained “elevated” in the Financial System Review published Thursday in Ottawa. Housing markets in the provinces of Alberta and Saskatchewan have “slowed notably” on lower commodity prices and some types of riskier consumer lending are growing at a time of record debt burdens, policy makers said in the semi-annual report.

“The vulnerability associated with household indebtedness is edging higher, and the overall risk to financial stability in Canada is slightly higher than it was at the time of our December FSR,” Governor Stephen Poloz told reporters.

The central bank is seeking to balance the risks of record consumer debt burdens against the shock to incomes from lower crude oil prices. Policy makers cut their key interest rate to

0.75 percent in January to aid growth, and Poloz said the economy’s 0.6 percent annualized first-quarter contraction mirrored the bank’s April forecast that output would be flat.

“The handoff is clearly a negative one,” Poloz said of the first quarter, “but it’s not a big miss.”

‘Weather Effects’

“They were trying to underline a more balanced approach to risk on financial stability,” said Nick Exarhos, an economist at CIBC World Markets in Toronto. That caution showed up in Poloz’s economic comments as well, said Exharos, who predicts second-quarter growth at a 0.7 percent pace rather than the bank’s April prediction of 1.8 percent. “He isn’t going to show his hand just yet” and will wait until the next full forecast in July, Exarhos said.

Some investors predict Poloz will cut rates again later this year, and weakness has extended into the second quarter -- Canada posted its second-largest trade deficit ever in April. Poloz said that while the negative forces of the oil shock are more immediate, positive forces such as cheaper gasoline for consumers and exports boosted by a weak dollar can still drive a recovery.

“The trade data were disappointing so far and there could be some weather effects mixed up in that,” he said. “But we’ve got some good data from the U.S. and some good data from our labor market here so we have positives and negatives that I can throw at you.”

Housing Overvaluation

Canada added 58,900 jobs in May, led by the biggest manufacturing gain in four years. Poloz also said both oil prices and Canada’s dollar are higher than the bank assumed in its April forecast.

Canada’s dollar remained weaker after the central bank’s report, down 0.6 percent to C$1.2323 per U.S. dollar at 12:48 p.m. Toronto time.

On housing, the bank estimated the range of overvaluation is between 10 percent and 30 percent, unchanged from the last report on Dec. 10. The “elevated” risk label for housing and consumer finances is the middle of five risk categories in the report.

Household debt reached a record 163.3 percent of disposable income in the fourth quarter according to a March 12 Statistics Canada report, with the first-quarter figures due out Friday. The cheapest mortgages in decades and sustained growth in Canada’s job market are encouraging consumers to load up on debt.

‘Significant’ Stress

There is a “low” probability of the housing correction emerging, the bank said, although if it did, it would have a “severe” impact on the economy and financial system.

“Although the low price of oil has increased the vulnerability of the Canadian financial system to future adverse shocks, it is unlikely, on its own, to trigger significant financial system stress,” the report said.

The most likely outcome in the housing market is for the risks to ease as the economy improves, the bank said today. Policy makers reiterated Thursday the economy is “expected to rebound in the coming quarters” from the oil shock, supported by stronger U.S. growth and easier financial conditions.

Housing markets are faring better outside of Alberta and Saskatchewan, the bank said. British Columbia and Ontario home sales “have remained strong,” while in the provinces east of Ontario price growth remains “weak.”

Two other risks related to the global economy remained unchanged today from December: a jump in interest rates again rated as “moderate,” and the “elevated” danger of a slump in China and other emerging markets.

Apart from damaging outcomes the bank labeled “risks” today, Canada faces “vulnerabilities” such as signs some investors are chasing riskier investments in a time of low interest rates.

(Updates with Poloz comments from third paragraph.)
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