May 18, 2023
Bank of Canada sees financial stress rising among homebuyers
Global economic weakness might be enough to loosen Canadian rates sooner than expected: Strategist
Early signs of financial stress for households are emerging and many of them now have less financial flexibility, the central bank said in its annual review of the financial system published Thursday. Recent homebuyers are extending their loans to make payments more manageable: The share of new mortgages with an amortization period longer than 25 years rose to 46 per cent from 41 per cent over the last year.
The share of new mortgages with a debt service ratio of more than 25 per cent — that is, where the payments consume more than a quarter of the borrower’s income — more than doubled during 2022, to 29 per cent.
A longer amortization period increases a household’s vulnerability as home equity is built more slowly, while a higher debt service ratio reduces flexibility for borrowers who experience unforeseen increases in expenses or losses in income. Home prices have fallen about 14 per cent since early last year.
The heightened concern about households increases pressure on Bank of Canada policymakers as they try to tame inflation without tipping the economy into a severe recession. With Canadian households among the world’s most indebted, many economists expect the economy to respond faster and be more sensitive to higher rates than peers.
Governor Tiff Macklem and his officials will next set rates on June 7. The majority of economists in a Bloomberg survey expect them to keep borrowing costs steady at 4.5 per cent for a third straight meeting, despite an unexpected acceleration in headline inflation to 4.4 per cent and a tight labour market that continues to churn out jobs.
Speaking to reporters after releasing the financial stability report, Macklem acknowledged that April’s consumer price data came in stronger than expected but said inflation is still coming down in line with the bank’s forecast. While swaps traders are putting higher odds on another hike in coming months, they see the central bank cutting rates within a year’s time.
“It is far too early to be thinking about interest rate cuts,” Macklem said. “We have some distance to travel to get inflation back to the 2 per cent target.” June’s decision will be guided by economic data, he added.
The governor and his officials have discussed the potential need for rates to stay higher for longer as part of their deliberations for recent decisions. He stressed in the press conference that the post-Covid economy is an altered landscape for many borrowers and financial firms.
“Nobody should expect that interest rates are going to go back down to the very low levels that we’ve seen over the last decade or so,” Macklem said. “We’re in a transition period to a world where interest rates are going to be higher than what many people have gotten used to.”
Canadian bonds rallied during the Macklem news conference, with the two-year yield falling about 5 basis points to 4.081 per cent at 12:21 Ottawa time.
The report flagged expectations for more households to face financial pressure as they renew their mortgages in coming months. “The decline in house prices has also reduced homeowner equity, and some signs of financial stress — particularly among recent homebuyers — are beginning to appear,” the bank said.
The share of indebted households that are behind on any credit payments for at least 60 days has been increasing since the middle of 2022. As more homebuyers became more reliant on credit card debt over the past year, the proportion of them carrying an outstanding balance has exceeded pre-pandemic peaks.
Households that took on a mortgage between 2020 and 2022 are carrying about 17 per cent more credit card debt on average than those that purchased between 2017 and 2019. Arrears on credit cards have also been rising and are close to pre-pandemic levels.
About one-third of mortgages have seen an increase in payments compared with February 2022, before the bank started its tightening campaign that has boosted rates by 425 basis points. By the end of 2026, nearly all mortgage holders will have seen their payments increase, the central bank said. If mortgage rates evolve in line with current market expectations, the median payment increase over the 2023-26 period will be about 20 per cent, the bank said.
While spillover effects to Canada from recent turmoil in U.S. regional banks have been limited, funding costs are rising for Canadian banks — a fact that could ultimately result in higher rates for consumers.
“If a severe recession were to occur, the balance sheets of Canadian banks could face pressures through credit and funding channels,” the central bank said, adding that significant unemployment and a large drop in house prices could lead to a deterioration in asset quality and increased credit losses for banks. With weakened market sentiment raising funding costs, “banks would likely reduce the supply of credit to households and businesses as well as that of liquidity to non-bank financial intermediaries.”