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Bank of Canada Says Home-Price Decline May Cause Consumer Spending ‘Shock’

Bank of Canada Says Home-Price Decline May Cause Consumer Spending ‘Shock’

Canadian consumer spending is at risk of a “shock” because of growth in borrowing linked to rising home prices, the country’s central bank said.

“There has been a steady rise in Canadian household indebtedness,” the Bank of Canada said in its Review document, a collection of academic papers. “Households could therefore experience a significant shock if house prices were to reverse,” including “a relatively large impact on consumption.”

Governor Mark Carney is relying on households for more than half of economic growth this year, after their spending led the economy out of a recession in 2009. Consumption has been fueled by the central bank’s 1 percent policy interest rate and commercial banks that are offering some of the lowest mortgage rates in decades.

“It isn’t necessary for everyone to have the most expensive house possible,” Finance Minister Jim Flaherty told reporters in Toronto today. “People have to be wise,” he said, because interest rates “have nowhere to go but up.”

Bank of Montreal cut its interest rate on five-year fixed- rate mortgages to a record low of 2.99 percent in January, prompting other banks to do the same. The banks have since announced an end to those offers, and the average posted five- year mortgage rate was 5.24 percent this week.

Debt-Income Ratio

The ratio of mortgage debt to disposable income has increased to almost 100 percent from about 50 percent over the last 30 years, the central bank report said. That gain has come with increased home ownership rates, house prices that have risen faster than incomes and low mortgage rates, the bank said in the Review. Home prices adjusted for inflation have increased 88 percent since 1980.

“The Canadian housing market has not exhibited the excesses seen in other countries,” the bank said. Last month it forecast that the ratio of household debt will continue to set records after reaching 153 percent in the third quarter.

“The evidence is that they do remain responsible,” Richard Goyder, vice president of personal lending at Royal Bank of Canada, the country’s largest bank by assets, said referring to consumers. “As the messages have come out about that debt level beginning to increase to levels that concern the Bank of Canada, consumers have responded by being a little more cautious.”

House-Backed Debt

Families are taking on more debt that is backed by their houses, with such loans accounting for about half of consumer credit in 2011, up from 11 percent in 1995, the bank said today. Increased marketing of such loans, their relatively low interest rates and rising home prices have contributed to the increase, the report said.

The share of home renovation spending financed by debt also peaked in 2007 at 38 percent, the bank said.

“This suggests that household spending on consumption and home renovation can become vulnerable to house-price shocks, since lower house prices would reduce the value of housing collateral and thus decrease household borrowing,” the report said.