The head of Canada’s central bank is warning consumers and chartered banks not to get caught by surprise when interest rates inevitably start to rise again.
Expanding on previous warnings, Bank of Canada governor Mark Carney told a business audience in Toronto that the current low interest rate environment may be luring Canadians to borrow too much, and banks to extend loans they will later regret.
Canadians have taken on more debt even during the recession, which is unusual, Carney said Wednesday.
But while Canadians may be able to afford the added debt burden now when interest rates are at historic lows, they may get caught short when rates return to more normal levels.
“The combination of sustained growth of household debt relative to income and a rising interest rate environment could increase the vulnerability of households to an adverse shock,” he said in his speech.
Carney reiterated the central bank’s commitment to keep interest rates at their historic low of 0.25 per cent until June 2010, although he said this approach could change if the economy bounces back more quickly than expected.
“Things can change and if things change we would change that guidance,” the bank governor told reporters after his speech.
“What we’re really looking for is supply-demand conditions in the economy… Demand’s starting to come back, that’s good, but there’s a lot of slack still to be picked up, and that’s important for the profile of how we would adjust monetary policy.”
While there is nothing to be particularly concerned about in terms of household debt levels right now, CIBC senior economist Benjamin Tal said that when interest rates do begin to rise they will rise quickly, and could catch some consumers – particularly those with large mortgages – off guard.
“He’s definitely saying, ‘Just be careful, because interest rates eventually will rise, because those are, after all, emergency interest rates.’ They will rise, and usually we know that when they rise they rise faster than they go down,” Tal said.
“What Carney’s telling you is – if you cannot afford this house that you’re buying now (at rates) 200 or 300 basis points higher, than buy a smaller house.”
Mortgage rates have been hovering at low levels for months while housing prices have rebounded dramatically, creating the perfect environment for consumers to take on big debt loads.
Although Carney said he doesn’t believe Canada is in the midst of a housing bubble, Scotiabank economist Derek Holt said this environment won’t last, and as interest rates start to rise and the number of new home listings starts to increase, it could post a downside risk to home prices, which would in turn hurt consumers with large mortgages.
“I would argue that we’re in a housing bubble that inflates for another year before material risks emerge by 2011 or thereabouts,” Holt said.
Wednesday was not the first time Carney and the central bank have voiced concerns about consumer debt levels. In the central bank’s semi-annual Financial Systems Review last week, it cited household debt as the number one risk factor to Canada’s economic well-being.
Since then there has been more evidence that Canadians have not paid heed. The Canadian Real Estate Association reported Tuesday that Canadians continued to snap up houses at near record levels, increasing their purchases of resale homes by 73 per cent in November.
Carney emphasized that he’s not telling consumers to stop borrowing, but is rather cautioning them to keep an eye on their finances.
“Everything in life is a question of degree, and it’s a question of, within the broad spectrum of consumers, who’s already borrowed enough and who else has additional capacity,” he said.
Among signs that Canadians may be getting in over their heads was a 41 per cent jump in personal bankruptcies in the July-to-September period compared to a year ago. Personal bankruptcies are now at the highest level as a proportion of the population since 1991.
As well, delinquency rates are rising and the proportion of mortgage payments in arrears by three months or more has increased by 50 per cent in the past year.
The Canadian economy is particularly vulnerable to household defaults since consumers are expected to be the key driver of economic recovery, the governor said.
But Carney added that while Canadian consumers have a responsibility to avoid credit risks, so do financial institutions.
“Financial institutions should actively monitor risk stemming from households and not take comfort from mortgage insurance and past performance of household credit,” he said.
“As our simulations suggest, the overall credit profile of Canadian households could well shift if debt continues to grow at current rates.”
Carney noted that he still believes the Canadian economy is coming out of the recession and will grow in the next few years.
He said he expects Canada to outperform the other G7 countries with a three per cent advance in 2010, but said growth going forward will be more modest than previous post-recession bounce-backs and more reliant on domestic demand.
“The behaviour of Canadian households will thus be particularly important,” Carney said.