Bank of Canada raises benchmark rate to 1.75% – October 24,2018

The bank of Canada announced it’s fifth consecutive raise (since July 2017) of 25 basis points to 1.75 per cent. Will the current generation of home buyers that have fueled Canada’s longest running home market boom be able to continue consuming? The central bank will now watch closely to see how tighter monetary policy is affecting the highly-indebted segments of the population.

The Bank of Canada has continued to paint a rosy outlook for the Canadian economy that has largely been supported by our unprecedented decades long hot real estate market. Today’s generation of new home buyers have been waned on over a decade of the lowest rates we have ever seen leading to the crazy consumption fuelled frenzy of home ownership and flexible home equity lines of credit.

You would have to be over the age of 45 to know that rates once were 12, 15, even 18 per cent and that some times housing markets slump and owners have to sell their negative equity homes in down markets- something many are struggling to realize today.

The government, through the Canada Mortgage and Housing Corp was the prime enabler of fueling mortgage indebtedness with its loose lending guidelines for insured mortgages. Subprime lending stayed in place years after it brought the U.S. housing market down. Then the feds walked it back to 100 per cent financing and 40-year amortizations. It was the wild west and the suit wearing feds played the role of lead cowboys.

Whenever money is made easy people always do foolish things with it. As a mortgage broker on the front lines I watched clients suffer and be herded through the crazy bidding wars and see clients be convinced to drop all the protective conditions in order to get the home they wanted. Everyone needed to keep up with the Joneses.

Slowly we all watched the housing market gather out of control and speed like an unmanned freight train as the CMHC tried to slowly slow things down and avoid the market going off the rails. In January 2018 the Office of the Superintendent of Financial Institutions put into effect a two-per-cent stress test for uninsured mortgages, a theoretical 2 per cent above a borrower’s contract rate ensuring that the borrower could handle rising rates that they will surely face upon renewal.

If you go back to just November 2016, 20 per-cent of new mortgages had a loan -to-income ratio in excess of 450 per cent. Today only 5 per cent of borrower’s carry loan-to-income above 450 per cent. Although this sounds heavy it in fact is in my opinion reasonable and shows soundness in a market with strong employment as a backdrop.

The Bank of Canada said last week that the quality of mortgages being issued had improved since the tighter lending rules took place. It also released results of a model it said showed Canadian banks’ capital positions would not be affected by a 20 per cent correction in the housing market. Let’s hope the bank is right about a shift occurring in the composition of demand away from consumption and housing towards business investment and exports.

Only time will tell if the redirection of household income to pay added interest payments will slow discretionary spending. Canadians paid $9 billion more in interest charges in 2017 than they did in 2016. And that number will only be higher in 2018 having seen three rate hikes this year.

The one thing that is for sure is that our economy will need to rely on another segment other that real estate to carry the weight going forward in order to avoid falling into a recession.