Bank of Canada governor warns rapid rise in home prices is ‘not normal’

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Bank of Canada Governor Tiff Macklem warned the housing market is “not normal,” as he released new research that suggests real-estate prices in some of the country’s biggest cities are being driven by a speculative frenzy.

The central bank singled out the Greater Toronto Area, Hamilton and Montreal as experiencing worrisome signs of “extrapolative behaviour,” which is the way Macklem and other policy-makers describe market dynamics they see as out of line with the fundamentals of supply and demand.

Ottawa, the sixth-biggest metropolitan area by population with about one million people, could soon join the list of trouble spots, the central bank said in its latest Financial System Review (FSR) on May 20. The central bank uses the report to assess vulnerabilities in the banking system that could trigger a financial crisis if exposed to the right shock.

“It’s important to understand that the recent rapid increases in home prices are not normal,” Macklem told reporters. “Even without a shock, some of the factors that cause prices to rise fast could reverse later and that could leave some households with less equity in their homes.”

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Vulnerabilities are different from risks in Bank of Canada parlance because officials aren’t saying a financial crisis is a possibility. Rather, they use the FSR to flag issues that could turn into bigger problems. The bully pulpit is the central bank’s main tool for exerting influence over the financial markets because it has little formal regulatory power of its own.

It’s important to understand that the recent rapid increases in home prices are not normal

Tiff Macklem, Governor of the Bank of Canada

Policy-makers listed six weak points in total: elevated levels of household debt; a frothy housing market; fragilities in the market for corporate debt; a “high potential” that demand for cash and cash-like assets could outstrip supply in the face of a panic; the threat of cyberattacks; and too many assets whose prices fail to reflect their exposure to climate change.

Housing is the vulnerability that appears to be generating the most concern. Since the summertime rebound last year in housing activity, the market has been relentless, despite waves of lockdowns and job losses.

Propped up by government support and low interest rates, Canadians are pulling forward their plans to buy homes and demand for housing has surged while supply has scarcely caught up. Years of underbuilding have left Canada with the lowest number of houses per 1,000 people of all the G7 countries: 424 units per 1,000 people compared with the group average of 471, according to research by the Bank of Nova Scotia.

The supply shortfall, in part, has led to a 23-per-cent jump in national housing prices since the start of the pandemic, the bank said in its review. The “chronic insufficiency” suggests “house prices are likely to trend upward for the foreseeable future given the years it would take to close the gap between supply and demand,” Scotiabank chief economist Jean-François Perrault wrote in a May 12 report.

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House prices are likely to trend upward for the foreseeable future given the years it would take to close the gap between supply and demand

Scotiabank chief economist Jean-François Perrault

Macklem also said supply-and-demand dynamics explain most of what is going on in housing, but not all of it. The bank released a new analysis that suggests the froth in the GTA, Hamilton, Montreal and to some extent Ottawa is being caused by speculation and unreasonable bets that prices will keep rising. Those markets are marked by bidding wars and evidence that sellers are reaping fat profits from final sales that far exceed the listed price.

“We do worry that households could be stretching,” said Macklem.

The FSR said 22 per cent of mortgages were 4.5 times bigger than borrowers’ incomes, more than the previous peak in 2016-17, when the central bank last observed that housing markets appeared to have come unmoored. Still, Macklem said he wouldn’t be raising interest rates to cool demand for housing, as the economy remains too weak. He did, however, endorse the federal banking regulator’s decision to require borrowers to pass a tougher stress test in order to qualify for an uninsured mortgage.

“Ottawa policy-makers at large are very, very careful not to do something rash that could affect everybody from coast to coast to coast,” said Robert Hogue, an economist at Royal Bank of Canada. “They’re trying to be much more surgical and this research will help in that endeavour.”

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After Macklem spoke, the banking regulator made good on its plans to tighten mortgage rules. The Office of the Superintendent of Financial Institutions (OSFI) confirmed that starting in June, the qualifying rate for uninsured mortgages will be either two percentage points above market rate or 5.25 per cent — whichever is higher. The current qualifying rate is 4.79 per cent.

For Mike Ursini, a real estate broker and the president of the Mississauga Real Estate Board, the exuberant markets are troubling because younger people are being priced out of the market. He’s unsure policy could make a big difference, as demand has been strong without interruption for the past 20 years.

“As long as we can move to a state where it’s normal again, I think (the market) will be okay,” Ursini said.

Financial Post

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