The Bank of Canada appears to have found a policy mix it can live with.
We tend to forget, but Governor Stephen Poloz cares almost as much about avoiding a financial crisis as he does about keeping inflation at two per cent, which is the central bank’s mandate.
The bankruptcy of Lehman Brothers Holdings Inc. and other cataclysmic events of 2008 showed there is no surer way to miss your inflation target than allowing a credit bubble to blow up on your watch. That was the U.S. Federal Reserve’s miss, but central banks around the world realized the same could happen to them. The Bank of Canada responded by putting extra emphasis on its analysis of the financial system, doing what it can to shine bright lights on weak spots that could lead to collapse if the wrong shock came along.
Some of those vulnerabilities are starting to look less vulnerable. The Bank of Canada’s annual Financial System Review (FSR) says household debt still is too high, but credit growth now is slowing and fewer high-risk borrowers are taking on more debt than they can reasonably afford. Similarly, sharp drops in home prices in Vancouver and Toronto since they peaked in 2016 suggest speculators have been chased from those markets, allowing the fundamentals of supply and demand to reassert themselves.
“The vulnerabilities associated with high household debt and imbalances in the housing market have declined modestly but remain significant,” the FSR concludes.
All things equal, if the threat of a credit bust is receding, the central bank can focus on ensuring Canada’s faltering economy generates enough growth to keep inflation on target. That likely means leaving policy exactly where it is.
The FSR credits various regulatory measures, including mandatory stress tests of mortgage borrowers and restrictions on international buyers in British Columbia and Ontario, for stabilizing financial conditions.
Policy makers also seem content with their interest rate setting.
The Bank of Canada tested households’ capacity for higher borrowing costs last year — and then quickly pulled back as soon as data showed they had reached their limits.
Poloz and his deputies on the governing council raised their benchmark interest rate a quarter point to 1.75 per cent in October and most on Bay Street expected a few more over the months ahead. But weaker consumer spending and a sharp drop in home sales, combined with the big drop in oil prices, forced the central bank to the sidelines when officials next considered interest rates in December. They have since lowered their economic outlook, and now almost no forecaster expects an interest-rate increase before 2020.
The shift in expectations have dropped mortgage rates by about half a percentage point this year. That should ease worries about what would happen as thousands of post-crisis, five-year mortgages came up for renewal this year. National Bank estimates that about 17 per cent of all home loans were scheduled for renewal in 2019. In January, economists at the Montreal-based lender said those borrowers were facing an interest-rate shock of between 70 and 90 basis points. Not anymore. The rate on an insured five-year mortgage is about three per cent, about the same as 2014.
“Canadian households are currently benefiting from a stellar jobs market, rising disposable income, and falling mortgage rates,” Matthieu Arseneau said in a note to clients on Tuesday. “As a result, the potential payment shock for homeowners set to renew their mortgage this year has almost vanished.”
The FSR shows the Bank of Canada has come to a similar conclusion. The report says the biggest threat to financial stability is a “severe recession,” but the central bank’s outlook calls for a rebound over the rest of the year. And the threat posed by a house-price correction is now classified as “moderate and decreasing.”
Things are moving in the right direction. So the central bank has every reason to leave policy alone.
• Email: firstname.lastname@example.org | Twitter: carmichaelkevin
Join the conversation →