“I think higher interest rates are always difficult when people haven’t seen them for a long time.”
— Carolyn Wilkins, deputy governor of the Bank of Canada
The pendulum continues to swing toward a more “normal” state of affairs, with the announcement this week from the Bank of Canada that it was raising its benchmark rate by 25 basis points, to 1.75 per cent, the fifth consecutive nudge upward. Prime lending rates at the big banks dutifully followed. Perhaps some mortgage holders will be number-crunching over brunch this Saturday morning, carrying out a self stress test just like Bank of Canada Governor Stephen Poloz once advised. What if the bank raises again and then again?
Does it relieve the pain at all to point out that my own mortgage once bore an interest rate of 12 per cent?
I thought not.
I’m not forecasting any such extreme outcome here. But it is instructive to recall that the BoC’s current rosy outlook for the Canadian economy is built on the backs of the current generation of new home buyers and the crazy consumption fuelled by home ownership and endlessly flexible home equity lines of credit.
It was consumers who kept us afloat, building a bridge to the new economy that the BoC says has now arrived in the form of expected business confidence and therefore investment (remember Mark Carney’s “dead money” comment from his own days as BoC governor? It has apparently reawakened in time for Halloween) and exports. This, we are told, is the contemporary composition of the economy. Historically closer to normal, in other words, albeit with declines in commodity prices.
The federal government, via the Canada Mortgage and Housing Corp., was a prime enabler of mortgage indebtedness with its too-loose lending guidelines for insured mortgages, chiefly 100-per-cent financing and 40-year amortizations. Crazy times. The walking back of too lenient lending started a decade ago. Step changes followed until January of this year when the Office of the Superintendent of Financial Institutions put into effect the two-per-cent stress test for uninsured mortgages, adding a theoretical 2 per cent to the contractual mortgage rate in determining a borrower’s ability to pay.
So the lending side, at least among regulated mortgage lenders, regained a level of sanity.
But what about the borrowers: how much do we really know?
On Wednesday, the BoC released its fall Monetary Policy Report. A red fever line that runs through Chart 4-B (try not to be bored) does a ski run from a point two years ago until today, illustrating the declining share of new mortgage borrowers with a loan-to-income ratio in excess of 450 per cent. Pinpointing November, 2016, to present day, we see a sharp decline from 20 per cent to slightly more than 5 per cent. The improved quality of new mortgage lending, the BoC was quick to say, is tied to changes in mortgage rules. Markets have cooled: you don’t hear of FOMO (fear of missing out), Poloz said in his Wednesday press conference, which seemed a strangely anecdotal, and unsubstantiated, comment for a data driven bank governor to say. Plus, he lives in Ottawa.
These super-debtors, or what Poloz calls the “upper tier,” have been a nagging concern. But this good-news data addresses a decline in the number of new highly indebted households only. In the press conference, Carolyn Wilkins noted that its still early days in assessing how the household sector is adjusting to the new regulatory changes.
In a footnote to its policy report the bank indicated that its analysis of the impact of the changes is forthcoming. “While policy measures have been effective in reducing household vulnerabilities, the sheer size of the outstanding stock of debt means that the vulnerability associated with elevated household indebtedness will persist for some time,” the report said.
That’s terribly mushy. Canadians deserve a granular analysis, which presumably the bank’s full analysis will provide.
Here’s a number to think on in the meantime, released by Environics Analytics last month: Canadians paid $9 billion more in interest charges in 2017 than 2016. And that’s before the three rate bumps of this year.
The fallout: will the redirection of household funds to interest payments dampen discretionary spending?
We all know the answer to that.
Stephen Poloz had better hope that the bank’s jolly economic outlook is spot on, that this “composition of demand shifting toward business investment and exports and away from consumption and housing” will bear out. It looks as though homeowners will be in no position to save the economy again.