Canada’s Mortgage Clampdown Means Economic Pain Now, Gain Later

  • Finance Minister Bill Morneau unveiled new measures last week
  • Moves to cool house-price appreciation to weigh on GDP growth

Canadian Prime Minister Justin Trudeau’s Liberal government is taking a little bit of economic pain now to prevent a much bigger problem down the road.

Real estate measures introduced by Finance Minister Bill Morneau last week will probably cool the housing market, reducing its contribution to already tepid gross domestic product growth, analysts say. That may be a small price to pay to lessen the odds of a real-estate crash in Toronto or Vancouver.

Bank of America Corp. cut growth forecasts this quarter and next on the view Morneau’s measures -- which apply a stricter standard to borrowers and close a loophole on foreign buyers -- will hurt sales. Most Canadian banks are still evaluating the impact of the new measures, and will closely monitor housing market data released Friday by the Canadian Real Estate Association.

“The new rules will likely slow down the housing market, which could weigh on growth,” said Emanuella Enenajor, an economist at Bank of America in New York. She sees 1.4 percent and 1.5 percent growth this quarter and next, down from 1.6 percent each previously. “We’re in the camp that the moves won’t trigger a severe downturn in housing but rather a temporary period of slowing activity.”

Wider Drag

The measures could reduce housing sales and prices between 5 percent and 10 percent in the next six months to two years, which could knock more than 0.5 percentage point off growth, according to estimates from Stuart Kraft, a strategist in Toronto at National Bank Financial. Therefore, Kraft said, if the economy is growing 1 percent to 1.3 percent annually, the changes would bring that rate to below 1 percent.

Beyond the drag on the wider economy, real estate outside the hottest markets may get hit. While prices in Vancouver more than doubled since 2005, they’re up just 40 percent on the Atlantic coast city of Halifax, Nova Scotia. Prices and sales in cities tied to the oil industry like Calgary have sagged along with commodity prices.

“The rough rule of thumb we’ve used in the past is a 10 percent decline in house prices is worth on the order of 1 percentage point off growth, mostly through the wealth effect,” Mark Chandler, head of fixed income research at RBC Capital Markets, said by phone from Toronto. He added that any decline -- if it occurs -- would be from already elevated levels and could have a muted impact when averaged over the whole year.

Erik Hertzberg/Bloomberg

Consumer spending, which has accounted for almost all of Canada’s growth over the last five years, is reaching an inflection point, with household debt now exceeding the size of the economy for the first time. Adding to the downbeat outlook, the hoped-for resurgence in the country’s export sector is proving to be fickle, and the two-year-old adjustment from an oil-price shock is still playing out.

Under the new mortgage-insurance rules, unveiled on Oct. 3, some families will have to save more to buy a house. Under the new rules, a family with C$100,000 of income could be approved to buy a C$490,000 home, compared with C$580,000 previously, according to Rick Lunny, chief executive officer at Manulife Bank of Canada.

‘Solid’ Contribution

Spending on big-ticket items such as fridges and sofas may suffer as families put aside more money to buy a home, said Craig Alexander, chief economist at the Conference Board of Canada in Ottawa. Any decline in house prices will also have indirect effects by making people feel less well off and potentially curbing home construction.

“Consumer spending growth is going to continue to be a solid contributor to Canada, it’s just not going to be capable of providing strong economic growth,” Alexander said. “Spending on furniture and appliances isn’t going to be rising as much.”

RBC predicts consumption and housing will contribute a combined 1.1 percentage points to growth next year, versus an average of 1.7 points over the past eight quarters, “so we had already factored in a slowing from that combination,” Chandler said.

Still, Morneau had little choice but to impose the new rules.

The International Monetary Fund and Organization for Economic Cooperation and Development have been warning for years of the dangers of consumer debt and rising house prices to Canada’s financial stability. Bank of Canada Governor Stephen Poloz said in June strong price gains in Vancouver and Toronto probably can’t be sustained by fundamentals. UBS Group AG said in a research note last month Vancouver was the world leader in bubble risks.

“Growth was already vulnerable as it had been too dependent on consumption and residential investment,” said David Watt, chief economist at HSBC Holdings Plc’s Canadian unit in Toronto.

— With assistance by Erik Hertzberg, Allison McNeely, and Theophilos Argitis

    Before it's here, it's on the Bloomberg Terminal.
    LEARN MORE