The Bank of Canada has created a perfect storm for house prices

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by Shaun Richards

One of the curious impacts of the Covid-19 pandemic has been the boom in house prices we have seen in so many places. If you think of the economic disruption and declines the economic theory would have predicted falls but that was before economic policy both monetary and fiscal stepped up to the plate. One clear example of this has been Canada which ended the week with its latest official house price data.

Nationally, new home prices were up 11.9% year over year in July, with the house structure (+14.1%) rising more than the land (+6.7%).

So we see another country with double-digit house price growth. In this instance it adds to a previous issue which is probably why the statistics office opened with this.

New home prices in Canada (composite of 27 census metropolitan areas) grew at their slowest pace since December 2020.

That theme has been picked up by the financial media but it begs more than a few questions.

Nationally, new home prices were up 0.4% in July. Prices in Toronto (+0.2%) and Vancouver (+0.3%), Canada’s most expensive cities, grew at a slower pace than the national average.

Actually if that rate of growth persisted and gave us 5% per annum it would still be way too much for the economic circumstances. But I guess that some have got so used to the increases they can no longer apply logic.

Explanation Time

Back in April the Bank of Canada was more revealing than it intended with this.

At the start of the COVID‑19 pandemic, Canada was facing two significant and interrelated financial vulnerabilities: imbalances in the housing market and elevated household indebtedness.

So the housing market was already in a mess as the central bankers faced the prospect of their worst nightmare of falling house prices and trouble for the banks via their mortgage book liabilities.

The Response

These two vulnerabilities had the potential to amplify the devastating economic impacts of the pandemic and create additional stress across the Canadian financial system. But with the help of unprecedented policy measures—including direct income support and debt payment deferrals—this risk has so far been avoided.

You may note that they point out government moves whereas many will concentrate on its own actions in March last year.

The Bank of Canada today lowered its target for the overnight rate by 50 basis points to ¼ percent.

That was on March 27th and was the third 0.5% interest-rate cut in that month as the overnight rate was slashed from 1.75% to 0.25%. It obviously did not believe that was enough as we also got this on the same day.

Second, to address strains in the Government of Canada debt market and to enhance the effectiveness of all other actions taken so far, the Bank will begin acquiring Government of Canada securities in the secondary market. Purchases will begin with a minimum of $5 billion per week, across the yield curve.

So short-tern interest-rates and longer term ones were targeted then on the 30th we saw that not only was the price of credit being aimed at but so was the quantity of it, and the emphasis is mine.

The STLF is one of several facilities the Bank of Canada has put in place to support liquidity in the financial system. Under the STLF, eligible financial institutions can borrow from the Bank of Canada by pledging a broad set of collateral, including mortgages. This improves their ability to fund new lending.

The same problem

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Returning to the research paper we see that whilst there is a brief effort at hyping wealth effects they are trying to get out of a hole by digging.

Strength in the housing market is contributing to Canada’s economic recovery from the pandemic. But it may also be intensifying housing market imbalances and household indebtedness.

may also? Actually they know that it has.

In particular, house price growth and mortgage indebtedness have risen amid an increasingly strong housing market.

The policy made things cheaper for those who were already well-off.

 For example, the upper end of the income distribution—where the majority of homebuyers are found—has seen little disruption during the pandemic. This, combined with record-low mortgage rates, has resulted in relatively strong demand despite the broader economic downturn and a decline in population growth.

Or as a footnote explains.

 Typically, more than half of homebuyers in Canada have household incomes above $100,000.

Debt and Savings

Both can boost a housing market and Canada saw a rise in the former.

Since the onset of the pandemic, the outstanding stock of household debt has risen by close to 3½ percent. This reflects an increase in mortgage debt  despite a pause in the first half of 2020.

I can update this as the research paper was from earlier this year and Thursday’s Statistics Canada update showed that in June residential mortgage lending had reached 1.73 trillion Canadian Dollars as opposed to the 1.66 trillion of February. In fact total lending for real estate rose over 2 trillion Canadian Dollars in June out of total lending to households of 2.53 trillion.

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On the other side of the coin the pandemic allowed others to save and presumably a fair bit of this went to those already well-off as described by the Bank of Canada earlier.

To summarize, these sizable shifts in income and spending resulted in an unprecedented increase in savings in 2020 of about $180 billion, or roughly $5,800 per Canadian

( Deputy Governor Schembri on 11th March )

Oh I think we know…..

 There is much uncertainty about what Canadians will do with these savings.

Well yes….

This is important because these savings are large enough to meaningfully affect the trajectory of the economy.

The Deputy-Governor eventually gets there.

Given the strength in housing market activity since the summer, some have been used to purchase houses, likely by higher-income earners.

Comment

There are various contexts to this of which the first is that house prices should not be rising in an economic slow down. Next comes the effort to imply that because the rate of growth is slowing things are getting better when in fact they are getting worse just not quite so quickly. Or

In July the Teranet–National Bank National Composite House Price IndexTM was up 2.0% from the previous month. Although this is a significant increase, it is now the second consecutive month in which the monthly price increase is lower than the previous month (2.8% in May and 2.7% in June).

Which can also be put like this.

The July composite index was up 17.8% from a year earlier, the 12th consecutive acceleration and the strongest 12-month gain on record.

Those are punchy numbers to say the least and they come on top of the existing Canadian boom. Quite an irony when you consider the space it has.

If we switch now to the policy issue it was deliberate but has sprayed into other areas if we go back to Deputy-Governor Schembri’s speech.

Bank research suggests about 40 percent of the extra savings was accumulated by high-income households. Their incomes were less affected, and they typically spend relatively more on non-essential and hard-to-distance items. On the other hand, low-income households accumulated less than 10 percent of the savings.

So we see that a combination of easing the debt for some has also seen a boost in savings for others. Some may have got both. But what about those left out who now face ever higher house prices? A trim in the buying rate of QE or even a stop does not help them much.

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