victorian-houses-montreal Photo: Maëlick/Flickr

The Bank of Canada has once more cited a sharp housing price correction as a key risk to the Canadian financial system and economy.

“The most important domestic financial system risk remains a severe recession and a sharp, widespread rise in unemployment that reduce the ability of households to service their debt, causing a broad-based decline in house prices,” the bank said in its bi-annual Financial System Review released Tuesday.

The central bank said the chances of this scenario unfolding are “low” but rated the risk of it happening as “elevated,” echoing concerns expressed in its previous Financial System Review report from June.

A correction isn’t likely, the bank said, because Canada has come out of a technical recession to see exports rise as the loonie remains low, bolstering the economy. Monetary easing, such as two Bank of Canada cuts to the overnight lending rate this year, has also helped.

Household debt, listed in the report as one of the vulnerabilities to the country’s financial system, is one of the major factors behind the “elevated” rating.

Low interest rates have encouraged consumers to take on higher levels of debt, according to the report. This has left younger households, who are taking on a rising share of debt, especially vulnerable, as the Canadian Centre for Policy Alternatives recently suggested.

These younger households typically don’t have the same resources and are often more leveraged than their older, more established counterparts, which means they could be hit harder by job loss or future Bank of Canada rate hikes.

“Nonetheless, the most likely scenario is a gradual decline in this vulnerability as the economy and incomes grow and interest rates slowly normalize,” the Bank of Canada report reads. Meanwhile, a number of economists from Canada’s biggest banks expect the key interest rate to remain at 0.5 per cent throughout 2016.

Imbalances in the Canadian housing market are another vulnerability for the country’s financial system.

“Vancouver and Toronto markets are large and represent about one-third of both the value of the total Canadian housing stock and the outstanding stock of mortgage debt,” the bank said. “A rapid correction in one or both of these markets would have a large direct effect on the Canadian economy and the financial sector.”

However, Stephen Poloz, the Bank of Canada’s governor, expects the housing market to overcome risks and vulnerabilities. “Housing activity should stabilize in line with economic growth, as the driver of growth in the economy switches from household spending to non-resource exports,” he said in a statement.

“Certain vulnerabilities are still edging higher, but recent changes by Canadian authorities to the rules for mortgage financing will help to mitigate these risks as we move into 2016.”

Last week, the Liberal government rolled out rules requiring a higher minimum down payment for homes over $500,000 that is set to come into effect in mid-February.

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