Poloz Sounds Alarm on Toronto and Vancouver Housing Risks

  • Bank of Canada warns strong price gains can’t be sustained
  • Household risk ‘finally coming home to roost,’ economist says

Bank of Canada Governor Stephen Poloz gave one of his bluntest warnings to date about the country’s housing boom, saying Vancouver and Toronto buyers should realize strong price gains probably can’t be sustained by economic fundamentals.

“This suggests that prospective homebuyers and their lenders should not extrapolate recent real estate performance into the future when contemplating a transaction,” Poloz said from Ottawa after publishing a semi-annual Financial System Review Thursday.

Policy makers have warned for years Canada’s inflated housing market poses the biggest risk to the country’s financial system. Thursday’s report suggests recent gains in the hottest segments may have altered the equation, and Poloz’s comments follow those last week from commercial bank executives who said regulations to tighten mortgage rules haven’t been effective enough.

“It appears we’re coming out the other end from the major risk of the oil price shock and the Bank of Canada is thinking ‘what is the next big shock that can hit Canada?’” Frances Donald, Manulife Asset Management’s senior economist, said by phone. “It’s household debt and the housing market risk finally coming home to roost.” 

In the FSR, the central bank pointed to surging Vancouver, where average price gains accelerated to a 30 percent year-over-year pace in May, from 15 percent at the end of last year. In Toronto, the pace of price gains quickened to 15 percent from 10 percent over that period. The two cities also lead a rise in the share of new mortgages whose loan-to-income ratio exceeds 450 percent.

Complex Conversation

The Bank of Canada won’t be offering advice to government officials on how to contain risks in housing, at least outside of formal channels, Poloz said at a press conference. Past steps to tighten mortgage rules have been successful in buffering the financial system, he said.

“They are stepping away from the idea that the house-price shock can be controlled,” Donald said. “The Bank of Canada putting so much emphasis on house prices suggests there’s a much stronger and more complex conversation happening with policy makers.”

Canadian authorities including Finance Minister Bill Morneau said in December they would raise downpayment requirements for homes above C$500,000 ($393,000), while making it more costly for banks to fund lending to that market. The measures were designed to cool surging prices in Toronto and Vancouver.

The government “welcomes the Bank of Canada’s analysis,” Annie Donolo, a spokeswoman for Morneau, said Thursday by e-mail. “We are continuing to monitor the housing situation very closely and will take an evidence-based approach to ensuring the longer-term stability of Canada’s overall housing market.”

Self-Reinforcing Expectations

Only an “extreme” risk to the bank’s 2 percent inflation target would lead him to shift monetary policy, said Poloz, who cut the trend-setting interest rate to 0.5 percent last year to cushion the blow from a crash in oil prices. There’s been no “sudden” change in risks that led to today’s warning, he said. “All of the evidence continues to accumulate, and also the longer that these risks prevail, the bigger the impact can be if the risks are actually triggered.”

Markets in Toronto and Vancouver are exposed to a cycle where rising mortgage debt and prices feed off each other as buyers rush to get into the market, the central bank said. “Fundamental factors underpinning housing demand in the greater Vancouver and Toronto areas are strong, but the rapid pace of price increases seen over the past year raises the possibility that prices are also being supported by self-reinforcing price expectations,” the bank said in the report.

The risk of a housing crash remained “elevated” in the FSR, which is the middle of five risk categories that range from low to very high. The probability of major damage from a housing correction “remains low,” the central bank said, citing the aid of a growing economy.

“It does seem it’s becoming a little bit more of a concern, the further this runs, just given the acceleration in what we’ve seen in home prices and other activity,” David Tulk, head of global macro strategy at TD Economics, said by phone from Toronto.

‘Uncharted Territory’

Any broad crackdown on the housing market would harm the home market in cities where sales and prices are already flat or cooling, Phil Soper, chief executive officer of Royal LePage, a unit of Brookfield Real Estate Services Inc. “We are in uncharted territory here,” he said by phone from Windsor, Ontario. “We’re probably looking at an approach that’s new to the Canadian economy, in the interest of a safer real estate market, which is a good thing.”

On the broader economy, Poloz said Thursday that Alberta’s wildfires are a big risk to near-term economic growth -- one that financial institutions should be able to withstand, even with record insurance claims that may hit C$6 billion ($4.7 billion).

The trend of a U.S. recovery that is aiding Canada’s exports remains in place and should trigger a rebound in business investment, Poloz said. “The export story that we have talked about is nicely intact,” he said. “Our view is still that a strengthening economy and rising incomes will reduce these vulnerabilities over time for the country as a whole.”

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