How much longer can consumers underpin Canada’s economy?

September 23, 2015

RTR4MCGY.jpgThe Bank of Canada is hoping the average Canadian continues to do the heavy lifting for the economy and gets it out of its rut from the first half of the year, even with dangerously high household debt levels. That may be a big ask.

Canada’s average household debt-to-income ratio is back at a record high of 164.6 percent in the second quarter, driven by mortgages, after inching lower in the previous two quarters.

Since the financial crisis Canadian household debt has increased at the second-fastest pace among developed nations, according to a recent McKinsey Global Institute study. Greece topped the list.

Citing figures from Ipsos Reid, a 2014 Bank of Canada report concluded that 40 percent of all household debt was held by borrowers who had a total debt-to-income ratio greater than 250 percent, compared to the average of 162.3 percent.

This segment of heavily indebted borrowers rose to about 12 percent in 2014 from around 6 percent in 2000.


Consumer spending – primarily related to the housing market – has been the main driver of the Canadian economy over the past five years. It buoyed and boosted Canada through the worst of the global financial crisis, even as the U.S. housing market and economy crashed.

CA house price

But now Canada’s economy has taken a sharp turn for the worse.

The jobless rate hit a one-year high of 7 percent in August as sharp falls in oil prices took their toll.

Even U.S. Federal Reserve Chair Janet Yellen cited the slowdown in Canada, an important U.S. trade partner, in its concerns about the global economy that led it to hold off yet again on its first rate rise in nearly a decade.

David Madani, economist at Capital Economics, wrote:

With the economy now in a slump and household incomes likely to grow more slowly as a consequence, household financial leverage is likely to climb dangerously higher.

Although debt interest servicing costs remain low, this completely misses the point in a high debt low interest rate environment. Moreover, we remain deeply concerned about the vulnerability of households to a correction in housing valuations that could see their net worth reduced significantly.

The Bank cut interest rates twice this year to soften the blow of the oil price shock, felt especially in the oil-producing province of Alberta.

It left rates unchanged at its September policy meeting saying the stimulative effects of previous monetary policy actions were working their way through the Canadian economy.

In the meantime, household debt is still climbing and consumer spending in the housing market has been spurred on even further.

CA Debt

Home prices have been rising steadily for the better part of a decade and many economists and property analysts are now warning Canada’s housing market is overheated and could be headed for a sharp correction, especially in Toronto and Vancouver.

A recent Reuters survey showed home prices will continue to rise despite a potential slowdown in buying if the economy continued to underperform.

Governor Stephen Poloz, however, has likely put on the back burner his own evaluation of the housing market being as much as 30 percent overvalued and a potential risk to Canada’s financial stability.

He continues to peg his hopes on more consumer spending and a weaker currency to drag the economy out of its slump.

Emanuella Enenajor, North America economist at Bank of America Merill Lynch, said:

Consumer spending leading growth is not necessarily the best formula for growth, given the amount of debt Canadian consumers have. A lot of that is mortgage driven but at the same time we are seeing an increase in consumer credit growth for autos and other durable goods. So, this is really not the key driver we should be seeing. It should be driven by exports and external demand. That is the kind of sustainable demand that’s possible and an environment where eventually if the Bank of Canada wants to raise rates, they will be able to without substantially slowing growth. 

Sadly, a weaker currency has failed to lift export demand so far and put into jeopardy the whole premise of Poloz’s optimism of a recovery in the second half of the year.

Elevated household debt, or more debt, is necessarily going to make a correction more likely. If and when that correction comes it will be more painful. 

But since the Canadian housing market has thus far defied expectations for a slowdown, the Bank would look at it as one of the few strands it could stretch to breaking point, and stand pat on policy until end-2016.

(With additional inputs from Rahul Karunakar)

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