In its latest review of the financial system, the Bank of Canada indentified three key financial system vulnerabilities, two of which related to the housing sector.
Although overall risks to stability were little changed, the central bank stated that household vulnerabilities had moved higher compared with the last review in December. The bank attached a lower probability to a downturn, but the overall financial impact would be larger. Housing concerns will tend to give the central bank less scope to relax monetary policy further if manufacturing conditions weaken further.
Firstly, there were concerns surrounding the elevated level of Canadian household indebtedness, which was also related to imbalances in the housing sector. There were concerns surrounding high house prices in the Vancouver, Toronto and adjacent areas with rising prices and high loan values relative to incomes. These imbalances would expose the financial system to serious stresses in the event of a deep recession, which pushed unemployment sharply higher.
The Bank of Canada also flagged risks associated with a sharp increase in long-term interest rates driven by higher global risks premiums, stress emanating from China and prolonged weakness in commodity prices. Although the possibility of stress from China was seen as a higher risk that the housing sector, any instability in housing would have a bigger negative economic impact. The bank assessed that the risks associated with the threats had increased, but the probability of an event happened had eased slightly due to an improved economic environment.
In addition, more technically, there were concerns surrounding fragile liquidity in the fixed-income market.
Governor Poloz stated that recent house-price increases in Toronto and especially Vancouver were unlikely to be sustainable with price expectations unlikely to be realised. The Governor stated that there was no precise way of measuring the risks of a housing bubble.
Poloz emphasised the primacy of the inflation target and only extreme risks to financial stability could force the bank to adjust monetary policy to override the inflation objective, but the bank will face increased barriers to any further rate cuts. He effectively called on lenders and borrowers to show restraint.
The Canadian dollar strengthened slightly on expectations that it would be slightly more difficult to relax monetary policy further, although a rally in oil prices was also important as USD/CAD dipped to 1.2720 from 1.2735.
Source: Economic Calendar