Policymakers have been worried about household debt levels for some time, and housing markets appear to be overvalued, too. Economists note that there are signs that households have got the message and are limiting credit growth, hopefully averting a hard landing for household finances, but the outlook for consumer spending is dimming as a result.
The Bank of Canada, among others, have been warning about the risks posed by household indebtedness. In particular, there’s a concern that when interest rates inevitably rise, many Canadians may find themselves in financial trouble as their interest burdens rise too.
In a new report, TD Economics observes that over the medium-term, it’s expected that interest rates will likely rise by at least two percentage points, and it says “there is no doubt that a significant minority of Canadian households will be at-risk when this occurs.”
In that report, it says that, according to the Canadian Association of Accredited Mortgage Professionals, roughly 21% of current mortgage holders, representing roughly 1.2 million mortgages, “may face financial difficulties with such an increase.” And, it notes that Bank of Canada research suggests that “as many as 7.5% of households could be put into a financially difficult position if interest rates normalize.”
Additionally, there are concerns that the housing market is overheated. Indeed, a new report from CIBC World Markets Inc. observes, “There is no debate about the fact that the housing market is overshooting. The only question is what will be the nature of the adjustment.”
Yet, there are hopeful signs that these adjustments will not be too painful. TD says that “there have been some preliminary signs that Canadians have begun to hunker down and/or protect themselves from interest rate increases”, noting that household consumer credit growth has slowed substantially in recent months.
This view is echoed in the report from CIBC, which says that “the pace of growth in household credit is no longer a reason for the Bank of Canada to move from the sidelines any time soon.” It says that, as of March, household credit is now rising at its slowest pace since 2002. Consumer credit outstanding actually declined in March, it says, and for the first time in more than a decade consumer credit in Canada is rising more slowly than in the US, it notes.
Moreover, households are doing a better job of managing their consumer debt, it says. “We see increased optimization of the debt burden with active transfer of balances from credit cards to lines of credit,” it says. And, it maintains that the delinquency rate is still very low.
This evidence of household restraint has economists optimistic about the prospect of a soft landing for household finances and housing markets. “While excessive debt levels remain the economy’s largest domestic medium-term threat, a combination of slowing credit accumulation, gradual increase in interest rates and efforts to lock-in at still-low fixed rates will help to ease the adjustment on households,” TD says in its report. And, as a result, it expects that the imbalances in the housing market and in the household debt-to-income ratio will unwind slowly, rather than dramatically.
CIBC says, “It appears that we are at a turning point in the real estate market,” adding that recent signals from the market suggest that activity is slowing down. “We continue to call for a gradual softening in the market, with prices potentially falling by around 10% in the coming year or two,” it says.
However, economists are not as sanguine about the outlook for consumer spending amid this sort of consumer deleveraging. CIBC says that, “With consumer credit growth slowing to a crawl, the housing market leveling off and potentially losing some ground, Canadian consumers will lose two of the main pillars of strength that made them the champion of the recent economic cycle.”
And, TD adds that the, “medium term prospects for consumer spending remain limited.”