OTTAWA — The Bay Street consensus is that the Canadian housing market skirted the worst and managed a soft landing and homeowners are likely able to absorb higher mortgage payments once interest rates head upward.
But one analyst warned Thursday that people are overlooking a key risk that threatens to push down housing prices by as much as 25% over the next several years: subdued wage growth in a low-inflation environment.
That mix could make mortgage payments increasingly onerous for households already carrying record levels of indebtedness, David Madani of Capital Economics said, adding the knock-on effects to consumer spending could be so significant they could push Canada into another recession.
“This reality, we suspect, has not been given very much consideration at all,” he said. “All I am trying to do is step back and look at the longer-term picture of affordability.”
In a low-inflation environment, it’s harder for asset prices and wages to rise to make the burden of debt more manageable, Mr. Madani said.
In a report to clients, he said the fall in prices could start this year if the Bank of Canada raises its benchmark rate, which stands at 1%. Mr. Madani, one of the few economists to predict no rate hikes for all of 2011, warned an increase could mark the “tipping point” as consumer sentiment could swing rapidly.
The federal government last month decided to toughen mortgage-lending standards for the third time in as many years in an effort to curb Canadians’ appetite for taking on too much debt, which is at a record 148% as measured as a ratio to disposable income.
This pessimistic view isn’t widely shared.
Gregory Klump, chief economist at the Canadian Real Estate Association, said he does not foresee such a scenario, given present economic fundamentals, whereby housing prices would contract by a quarter.
“The continuation of low interest rates would [help] support housing activity in 2011,” said Mr. Klump, who is in the process of updating his forecast for this year and next. CREA has said it expects housing sales to drop 9% this year, with the average house price falling 1.3%.
In a recent report, economists at Toronto-Dominion Bank said the worst-case fears, such as a U.S.-style housing collapsed, had been avoided. A trough in existing home sales emerged in the third quarter of 2010, or earlier than expected, TD said, and that “better” affordability would provide momentum while the Bank of Canada holds its policy rate as is until mid-2011.
But Mr. Madani doesn’t see it that way. The underlying theme in his analysis is that housing affordability would deteriorate, as inflation remains relatively low for some time. In a low-inflation environment, he argued, Canadians’ debt burden doesn’t dwindle as nominal rates (not adjusted for inflation) remain low and wage growth slows. In a separate report released Thursday, economists at Goldman Sachs said concerns over higher inflation in developed economies are “misplaced” and wouldn’t emerge until there is real GDP growth that exceeds potential “for some time.”
According to Mr. Madani’s calculations, the average house price, of $314,000 as of the third quarter of 2010, is roughly 5.5 times greater than the average level of disposal income, at $58,347. Historical data indicate the average house price is roughly 3.5 times greater than disposable income — which, he suggested, translates into an average value of $205,000 for a Canadian home, or 3.5 times above the $58,347 of disposable income.
To get back to a historical average, he calculates a housing price decline of roughly 25% over a number of years on the assumption that inflation-adjusted mortgage rates remain unchanged and growth in disposable income of 2% -- which is “slightly generous” given his low inflation outlook.
The Bank of Canada cited a “sudden weakening” in the housing sector as potential downside risk to its recently updated economic outlook. Such an event “could have sizable spillover effects on other areas of the economy, such as consumption, given the high debt loads of some Canadians.”
The central bank said inflation, both headline and core, would not converge to the preferred 2% target until late 2012.
Financial Post
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