Big banks downplay debt concerns
Viable home-loan renewals and low costs of borrowing among factors mitigating risks
OTTAWA— Canada sets interest rates Wednesday, and there’s widespread concern about what any further borrowing-cost increases might mean for consumers, their immense pile of debt and the housing market.
It’s one of the reasons to be bearish on Canada. Steve Eisman, featured in Michael Lewis’s book The Big Short, told Bloomberg TV this month that investors should short Canadian financials, citing looming housing “issues.”
The country’s largest lenders are warning against overplaying the concerns. While unprecedented debt levels pose risks, they say there won’t be any major upset to the economy for a number of reasons, including the view Bank of Canada Governor Stephen Poloz won’t press ahead with higher rates if signs of stress begin to emerge.
While the debt levels are a problem, “we don’t expect it to derail the economy, just because we expect Poloz to go quite gradually, or more gradually than what might have warranted hikes in the past,” Brittany Baumann, macro strategist at Toronto-Dominion Bank, said in a phone interview.
Other reasons not to panic — according to economists at the other five major commercial banks — include households’ ability to keep monthly payments on mortgages, a manage- able number of home-loan renewals and the still-low cost of borrowing.
That Canadians are heavily indebted is without question. Household debt has swollen to $2.1 trillion. Two-thirds of that is mortgages. With the central bank raising rates three times since July and with more hikes to come, there’s concern things could get messy.
Yet, rate rises will be gradual and it will take a while for that to flow through to households, according to Nathan Janzen and Robert Hogue at RBC.
The central bank’s effective household interest rate — a weighted-average of various credit rates — was 3.64 per cent on May 11, compared with 3.54 per cent in May 2013.
“It will take a while for the full impact of higher rates to hit household incomes,” Janzen said. “Household ability to pay is increasing along with interest rates.”
Canadian Imperial Bank of Commerce estimates only about 20 per cent of outstanding household debt has so far been exposed to higher rates.
Matthieu Arseneau at National Bank Financial says the “payment shock” from elevated household debt and rising rates will equate to a mere 0.24 per cent off aggregate disposable income this year. Considering real disposable income has grown about 2.5 per cent annually over the past decade, the shock will turn out to be more of a “slight touch on the brakes” of consumer spending.
Poloz has been mindful of the risks of the debt overhang. The central bank estimates that due to elevated household debt, the reduction in consumer spending “might be as much as 50 per cent more in the two years following a persistent change in interest rates.”
Such concerns have helped keep the central bank on hold since January. Poloz is expected to leave the benchmark rate unchanged at 1.25 per cent this week. Most economists anticipate debt worries won’t keep Poloz on hold. Derivatives trading suggests two more hikes by the end of the year, to 1.75 per cent, and Poloz has been emphatic that rates will eventually go higher.
The Bank of Canada estimates its “neutral rate” is about 3 per cent. BMO predicts two more rate increases this year and three next year. National Bank sees Poloz hiking twice more this year and twice next year. RBC projects 100 basis points of increases between now and mid 2019. TD predicts one more hike this year and one in early 2019.