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The governor of Canada’s central bank is warning the chances of price downturns in Toronto and Vancouver — the two hottest housing markets in the country — are increasing and that recent price gains are “unlikely to be sustained.”

Governor Stephen Poloz’s comments come with the release of the Bank of Canada’s latest Financial System Review, a twice-yearly report tracking vulnerabilities to the country’s financial system and exploring how they pose a threats to it.

Rising household indebtedness and an unbalanced Canadian housing market are among the vulnerabilities Poloz and the bank are flagging, though the governor says the financial system could withstand slumping home prices.

A vulnerability is different than a risk, the central bank notes, but can become one to the financial system if triggered by an event.

“Growth in mortgage credit and rising house prices are reinforcing each other in Vancouver, Toronto and their adjacent areas, leading to an increase in the share of mortgages with high loan values relative to income,” according to the report.

Some households could find themselves unable to cover their expenses in the face of unemployment or a surprise interest rate hike.

Debt and housing market imbalances were highlighted in the previous report from the Bank of Canada, published in December last year, but these vulnerabilities have worsened.

“However, in view of the improving economic outlook, there is now a lower probability that the risks stemming from these vulnerabilities will be triggered,” explains Poloz in the statement.

This amounts to an outlook roughly in line with December’s report, Poloz states — but there is a caveat.

“The pace of house price increases in Toronto, and especially Vancouver, is unlikely to be sustained, given underlying fundamentals,” Poloz continues.

The Financial System Review suggests home prices might be getting pushed higher as a result of “self-reinforcing expectations”

In April, Robert Kavcic, a BMO senior economist, outlined how this may be playing out in Vancouver. “The concern is that rising prices don’t slow activity, but rather beget even higher prices.”

The benchmark price for a detached home in Vancouver in May was $1,513,800, up 36.9 per cent from a year earlier, according to the Real Estate Board of Greater Vancouver.

In Toronto last month, the average detached home price reached $1,285,693, an increase of 15.2 per cent over May 2015, said the Toronto Real Estate Board.

Poloz adds, “Indeed, the potential for a downturn in prices in these markets, although difficult to quantify, is growing.”

Though the governor suggests the Canadian financial system could withstand a housing market downturn, he notes more than just home owners would be affected.

“A significant decline in house prices could have material consequences for some individuals and for some entities in the mortgage business,” he says.

“However, the financial system as a whole is resilient enough to handle the potential impact.”

Poloz says the bank’s governing council, which is its policy-maker, views “financial stability risks” as unchanged since December 2015.

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