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Canadians may be finally heeding Bank of Canada warnings about record household debt, but sky-high home prices backed by large mortgages remain a concern as the threat of higher interest rates and a possible drop in home prices inches closer.
A recent report from CIBC economist Benjamin Tal says growth in household credit is beginning to slow. In March, household credit rose by over 5 percent from last year -- marking its slowest pace of growth since 2002.
Tal says the key factor in the slowdown is a pullback in consumer credit, which includes credit cards and lines of credit. Overall, consumer credit rose 2.3 percent in March from last year, Tal says -- the slowest pace of growth since the early 1990s.
"Regardless of how you measure it, there is a clear slowing trend in the pace of growth in household credit," he says. "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."
The Bank of Canada recently left its benchmark interest rate unchanged at one percent, but warned that "some modest withdrawal of the present considerable monetary policy stimulus may become appropriate."
Tal also says that for the first time since 2002, Canada's consumer credit is growing at a slower pace than in the U.S.
"Note that as opposed to popular perception, consumer credit in Canada rose much faster than in the U.S. during the past decade," he says. "In fact, during the leveraged period of between 2002 and 2008, consumer credit in Canada rose twice as fast as in the U.S."
Tal says that while growth in consumer credit went negative in the U.S. after the financial crisis, it accelerated in Canada.
And as concerns over the state of Canada's housing market reach fever pitch, with everyone from bank executives, the finance minister and Bank of Canada Governor Mark Carney warning about high home prices, Tal says a mild correction is on tap.
"We continue to call for a gradual softening in the market, with prices potentially falling by around 10 percent in the coming year or two," he says.
Tal says that while it's clear that the real estate market is "overshooting," recent signals suggest that market is at a "turning point."
Tal says the amount of mortgages outstanding rose by 6.3 percent, well below that average rate of growth of 7.3 percent posted over the last two years and during most of the last decade.
Tal's remarks come after Canada Mortgage and Housing Corporation released data on Tuesday showed Canadian housing starts surged to 244,900 units in April, up from 214,800 in March -- and blowing past expectations for 202,000 starts. Much of that increase was a result of condo construction, which hit it second highest level on record.
A number of economists quickly warned that such a level of activity was unsustainable.
RATES COULD JUMP BY FALL
With Friday's jobs report further fueling speculation that the Bank of Canada is preparing to hike rates, economists are concerned about the impact such a move will have on households carrying record levels of debt.
"It is safe to say that with household debt levels at record highs, a sizeable number of Canadian households are ill-prepared and could lead to difficulty keeping up with higher interest payments when rates eventually increase," says Francis Fong, an economist at TD, recently.
Fong says that while credit growth is showing signs of cooling, mortgage growth continues to surge higher -- increasing by 7 to 8 percent pace annually over the last three years. That mortgage growth comes as the average price of an existing home has increased by about 30 percent over the past three years and is now 15 percent higher than they were before the pre-recession peak.
"The challenge lies in that mortgage credit seems unyielding and income growth is simply not sufficient to bring down the debt-to-income ratio, leading to an increasing level of vulnerability among households," he says.
Fong expects interest rates to begin moving higher this fall and will grow by 1 percentage point over the next two years and will be two percentage points higher by 2015.
"While the majority of Canadians appear to be well-positioned to absorb a rate increase of around 2 percentage points, there is a substantial minority that cannot," he says.