Canadian Household Leverage, Credit Growth Slowly Easing

Bank of Canada's January rate cut sees some vindication
July 1, 2015 Updated: July 2, 2015

As far as the high level of Canadian household debt goes, the Bank of Canada’s surprise rate cut on Jan. 21 is looking like one factor that has helped the situation improve.

Financial stability concerns stemming from an overheating housing market and highly leveraged households wouldn’t ordinarily suggest a rate cut is needed to make things better. But with the sharp drop in oil prices being the most significant problem the central bank had to deal with, a rate cut to help boost aggregate income and spending was the medicine it prescribed.

BoC governor Stephen Poloz reiterated his rationale for the rate cut in a panel discussion at the Bank for International Settlements (BIS) in Basel, Switzerland, on June 28.

He talked about a “neutral zone” for monetary policy, meaning inflation is at or is expected to reach its target within a reasonable timeframe and financial stability risks are evolving in a constructive manner. Canada had been in this neutral zone since late 2010, but that changed in January.

“The oil shock was big enough to move us out of the neutral zone, so we eased monetary policy in January,” Poloz said.

He admitted the rate cut was very controversial, as the central bank would be questioned about the risk of worsening the financial vulnerabilities from the housing sector.

“We were hoping to boost spending to offset the impact of the oil shock,” Poloz said. The Bank figured some of this spending could come from more borrowing.

“Our primary mission is to achieve our inflation target. This means getting the economy back to full capacity over a reasonable timeframe. Other issues must be subordinate, and I think of them as side effects,” Poloz said.

“If the doctor says you need surgery to avoid death, the side effects usually don’t deter you. You just go ahead and manage them somehow.”

And yes, housing markets in Toronto and Vancouver have gotten even hotter. The Canadian Real Estate Association reported on June 15 that the national average sales price rose 8.1 percent on a year-over-year basis in May, but that the national average increase was only 2.4 percent excluding Vancouver and Toronto.

The oil shock was big enough to move us out of the neutral zone, so we eased monetary policy in January.
— Stephen Poloz, Governor, Bank of Canada

That is one side effect of the BoC trying to achieve its primary objective of a 2 percent inflation target and getting the economy back to full capacity within a reasonable timeframe.

The rate cut in January hasn’t affected longer-term fixed mortgage rates, which continue to hover near historic lows and take their cues from corresponding government bond yields. If anything, the rate cut has made variable-rate mortgages slightly cheaper, but only about one-third of Canadians have variable-rate mortgages, according to

Less Leverage

“The economic impact of the oil shock is to reduce national income. The leverage ratios, that we watch so carefully, will go up whether there’s any more borrowing or not,” Poloz said.

“Cutting rates mitigates the rise in those leverage measures. There are risks associated with doing nothing too.”

One of those leverage ratios is debt-to-disposable-income, which in the first quarter edged lower to 163.3 percent from a record-high 163.6 percent in 2014’s fourth quarter, according to Statistics Canada on June 12.

The agency also reported that disposable income increased (0.9 percent) at a faster pace than household credit (0.7 percent), which led to the slight drop in the ratio.

Total Canadian mortgage debt stands at $1.301 trillion—up 5.5 percent in the last year. The three-month average growth by 5.0 percent is the lowest since last July, according to the Bank of Canada’s monthly credit conditions statistics for May, which were released June 29.

More broadly, total household credit of $1.835 trillion, which is made up of mortgage debt and consumer credit, is growing at a slower pace based on the three-month trend—4.5 percent. The last time total household credit grew at a slower pace was also last July.

Poloz envisioned a household with no debt deciding to get a mortgage due to the lower rate (i.e. spending), rather than a highly leveraged household adding to its debt load.

So while there are a number of economic factors that push and pull the growth of household credit, the Bank of Canada’s rate cut would seem to be having the desired effects with these measures.

Poloz explained that stronger incomes make higher indebtedness more sustainable, but should financial stability risks get too high, further macroprudential measures would need to be enacted, which isn’t usually the central bank’s duty.


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