The more the Bank of Canada sifts through the data left behind by the housing boom, the clearer it becomes that the economy would be in trouble if we weren’t so willing to borrow.
Last month, the central bank published a staff note that shows household borrowing against the country’s various real-estate bubbles created a significant amount of domestic demand in recent years.
Higher home prices influence consumption by triggering wealth effects that make us feel richer and, therefore, keener to spend. But we couldn’t act on that impulse without a mechanism to turn paper wealth into cash. It’s the collateral effect that yokes housing prices to spending, since rising values allow individuals to take out bigger lines of credit.
About 380,000 people in 2017 refinanced their mortgages, and another two million had a home equity line of credit, according to the Bank of Canada study, which was based on anonymized credit bureau data of some 25 million consumers. Combined, they borrowed roughly $89 billion, an increase of about 40 per cent from 2013.
The boost in debt at least partially explains how Canada posted surprisingly strong economic growth in 2017, when gross domestic product increased three per cent, the most in the Group of Seven advanced economies.
“Our results establish that equity extraction is economically important in Canada,” the central bank’s Anson Ho, Mikael Khan, Monica Mow, and Brian Peterson wrote. “In particular, we find that increased equity extraction has likely contributed materially to consumption and renovation spending in recent years.”
Governor Stephen Poloz and other leaders at the central bank are probably conflicted by those findings.
On one hand, the results confirm that monetary policy still has a kick. Lower interest rates can be relied on to stoke mortgage lending and construction, as well as additional spending, at least as long as asset prices are rising. That’s useful information for a policymaker.
At the same time, the central bank must be apprehensive about the extent to which Canada’s recent prosperity relies on debt.
Equity extraction dipped in 2018, as Poloz and his deputies on the Governing Council raised interest rates three times and real-estate prices dropped in Vancouver and Toronto. Demand that was based on rising incomes and solid consumer confidence might have pushed through moderately higher borrowing costs. But Canadians recoiled at the sight of fixed five-year mortgage rates north of five per cent, which was still lower than pre-crisis levels, but around 15 per cent higher than a year earlier.
That sensitivity to interest rates doesn’t leave the bank with much margin for error. Household consumption barely grew in the second quarter of 2019, despite robust jobs growth, suggesting higher borrowing costs were squeezing demand.
Unless, of course, all that debt is starting to weigh on consumption. That would be a problem because the trade wars are killing exports and business investment. Canada can’t afford to lose a third economic engine.
Debt is already growing much faster than wages, a dynamic that probably isn’t sustainable. Compensation per hour worked increased only about 11 per cent between the start of 2013 and the end of 2018, according to Statistics Canada’s quarterly report on labour productivity .
The share of income needed for interest payments rose to a record in Q2 2019. An upward shift in the debt-service ratio of one percentage point will slow consumer spending by 0.2 percentage points a year into the future, according to research by Toronto-Dominion Bank.
“Spending more of your income on keeping your debts current leaves less money for other priorities,” Brian DePratto, a TD economist, said in a report on Sept. 30. “Recent dynamics have underscored just how much high household indebtedness has amplified Canadians’ sensitivity to rising borrowing costs.”
He added, “This is one of the reasons why, until the relative debt burden shows meaningful improvement, the current level of 1.75 per cent is as high as the Bank of Canada’s overnight rate is likely to go.”
If not for the trade wars, interest rates would definitely be higher. Canada added 54,000 jobs in September , pushing the employment rate to about 75 per cent, the highest on record, Statistics Canada reported on Oct. 11. The jobless rate dropped to 5.5 per cent, a level that economists associate with full employment, the theoretical state at which everyone who wants a job can find one.
The country is still feeling the effects of oil prices collapsing in 2014 and 2015, and the global economy is decelerating quickly, yet Canada’s labour market has rarely been stronger.
“High levels of consumer debt may concern some observers, but they are likely to be sustainable amid low interest rates and continued job and wage growth,” Julia Pollak, an economist at ZipRecruiter, a digital job-matching platform, said in an email.
Wage growth could be the most important indicator for the central bank in the months ahead. There is evidence that Canada’s impressive run of job creation is finally forcing employers to pay up in order to attract and keep workers as the labour pool shrinks.
The number of job seekers in September who had been unemployed for more than 27 weeks dropped to 158,600, the second fewest since before the financial crisis. Average hourly wages surged 4.3 per cent from a year earlier, one of the fastest increases since early 2009.
And what are Canadians doing with their fatter paycheques? Borrowing money, of course. Consumer credit jumped 5.1 per cent in August, the biggest increase in two years, according to the Bank of Canada’s most recent tally. That debt will help the economy in the short term, and give the central bank a reason to leave interest rates unchanged. Households appear to be doing fine for now.
Copyright Postmedia Network Inc., 2019