Bank of Canada Governor Tiff Macklem said rising interest rates aren’t expected to derail the nation’s economy and may even produce a “healthy” slowdown in the housing market.

Macklem, speaking Thursday after the release of the central bank’s annual report on financial stability, argued home-price gains during the pandemic were unsustainable and produced vulnerabilities among new buyers who were forced to take on extremely high levels of debt.

“The economy can handle -- indeed needs -- higher interest rates,” Macklem said in an opening statement to reporters. “Moderation in housing would be healthy.”

Thursday’s report is the first comprehensive statement about the risks to Canada’s financial stability since Macklem began tightening policy in March. The Bank of Canada has increased its main policy rate to 1.5 per cent, from 0.25 per cent earlier this year, and is expected to rapidly hike borrowing costs to 3 per cent by October.

Macklem’s comments on housing mirror the central bank’s policy statement last week, in which officials expressed little worry about the impact of any sharp correction in the housing market. But he said policy makers are particularly focused on heavily indebted households that are more vulnerable to higher borrowing costs and are carrying less equity to cushion against any significant price declines.



Canadians who purchased homes recently would be “more exposed” in the event of a correction, according to the 57-page report. Many households stretched themselves financially to get into the housing market, which saw price gains of nearly 50 per cent since the beginning of the pandemic.

“If the economy slowed sharply and unemployment rose considerably, the combination of more highly indebted Canadians and high house prices could amplify the downturn,” Macklem told reporters, adding it could have “broad” implications for the economy and financial system. 

“This is not what we expect to happen. Our goal is for a soft economic landing with inflation coming back to the 2 per cent target,” he said. “But it is a vulnerability to watch closely and manage carefully.”

In its report, the central bank said it’s “too early to tell” whether the recent drop in home sales and prices is temporary or “the start of a deeper, lasting decline.”

Officials did, however, express some worry that investor sentiment that fueled home price gains during the pandemic could reverse and amplify price declines.

How this analysis and the interaction between risks and vulnerability plays into monetary policy is ambiguous. Worsening vulnerabilities could give policy makers less confidence about raising borrowing costs for example. But higher rates reduce inflation risks and would help rebalance the nation’s housing market. 

The central bank estimated the share of new mortgages this year going to highly indebted households -- those carrying loan to income ratios above 450 per cent -- has surpassed pre-pandemic levels to hit new records.