Photo: PT Money
A slight increase in interest rates is all it would take to spell serious trouble for many Canadian households too accustomed to the current low levels, an economist at a global economic research firm is warning.
“While low rates are a blessing during the initial stages of any economic downturn, they can become a curse if households become addicted to them,” reads a report that David Madani, Capital Economics’ senior economist in Canada, recently produced.
In the commentary, Madani — once labeled “the economist realtors love to hate” — argues the low interest rates that have been a boon to the economy in recent years have “encouraged” household consumption and housing investment to reach a record share of the GDP in the third quarter, leaving some households overleveraged and “utterly unprepared” for a rate hike.
Madani notes that debt repayment is now making up what is approaching an all-time high share of household income — despite interest rates actually declining. “Accordingly, even small increases in the market rates could hit the economy hard,” he states.
“Household indebtedness is a major vulnerability to the economy,” adds Madani in the research note, citing the Bank of Canada’s most recent Financial System Review, also published this month, which underscores that point. (So did the Canadian Centre for Policy Alternatives in November.)
Further stoking the flames is the fact that some debt consumers have racked up is being put towards mortgages on homes that are considerably overvalued. In Toronto and Vancouver, says Madani, homes are overvalued by more than 30 per cent. “These key regional markets are long overdue for a major correction,” the report states.
“Canada’s economy has long been overly reliant on household consumption and housing as drivers of economic growth,” explains Madani.
Madani adds it is possible the Bank of Canada may ease rates further in 2016, a scenario that increases in likelihood if oil prices continue to sink. However, Capital Economics is forecasting rate increases within two years as US Treasury and Government of Canada bond yields climb.
“Under these circumstances, we would expect household borrowing cost to rise,” concludes Madani. “Unfortunately, even small increases may prove devastating to many households with excessive debt loads.”