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Bank Of Canada Says It Won’t Fight Rising House Prices ― That’s Ottawa’s Job (Analysis)

The world's central banks are stuck between a rock and a hard place.
Bank of Canada Governor Tiff Macklem takes part in a news conference in Ottawa, Ont., Sept. 10, 2020.
Blair Gable / Reuters
Bank of Canada Governor Tiff Macklem takes part in a news conference in Ottawa, Ont., Sept. 10, 2020.

The Bank of Canada is aware that its emergency pandemic policies are inflating house prices, and it’s going to keep an eye on the country’s heavily indebted households, but in a speech Thursday, its governor made clear he plans to do nothing about it.

In essence, Tiff Macklem has said it’s the federal government’s job to worry about that, not the central Bank’s.

Not in so many words, of course ― this is the Bank of Canada we are talking about.

Macklem told a virtual audience at the Global Risk Institute that he means to keep the emergency measures ― rock-bottom interest rates, purchases of Canadian mortgages and government debt ― “in place for a long time.”

Watch: Can U.S. print infinite money to rescue the economy from the coronavirus? Story continues below.

And he made it clear that soaring house prices won’t change the Bank’s direction.

“We will watch the evolution of financial vulnerabilities closely, particularly given our commitment to keep interest rates low,” Macklem said.

“But if too many Canadian households start to become dangerously over-leveraged, policy-makers have several macroprudential tools they can use. Our experience with the mortgage-interest stress test shows how effective these tools can be.”

In this case, the term “macroprudential tools” means government regulation ― things like mortgage insurance, foreign buyers’ taxes or empty-home taxes or, as Macklem mentioned, the mortgage stress test.

Macklem’s statement “should reinforce the view that the Bank of Canada will keep their administered (interest) rate pinned down for the next few years, even if that policy contributes to increasing vulnerabilities,” CIBC economist Royce Mendes said in a client note.

“In that case, the Bank would look to other policymakers to contain any growing risks, given that raising rates prematurely would also stunt the recovery.”

Feds in wait-and-see mode

The average resale price of a home in Canada jumped by 18 per cent in August, compared to a year earlier, one of the strongest gains on record despite the ongoing economic crisis.

Economists ― and the Bank of Canada itself ― point to the Bank’s lowering of interest rates this year as a major reason. Capital Economics estimated recently that the drop in mortgage rates over the past year has increased buyers’ maximum purchase price by 24 per cent.

So far, the federal government has taken few steps to cool the recent house price growth, and its latest announcement ― a promise in last month’s Throne Speech to expand the use of the First-Time Home Buyer Plan ― is a “demand-side” policy that would increase the amount of money Canadians can spend on a home. It’s unlikely to reduce house price growth.

“Without the fiscal and monetary policy actions, the economic devastation of the pandemic could have been much, much worse.”

- Bank of Canada governor Tiff Macklem

On the supply side of things, the government announced a $1-billion program last month to convert unused hotel spaces into 3,000 new affordable housing units. The experts increasingly say certain Canadian cities are suffering from a chronic shortage of housing, pushing up prices.

Earlier this year, the Finance Ministry announced a tweak to the mortgage stress that would also expand, slightly, how much money buyers can spend on a home. But that tweak was put on hold amid the pandemic, according to a report at the Financial Post.

During the 2019 election, Prime Minister Justin Trudeau announced plans for a federal foreign buyers tax, similar to the ones British Columbia and Ontario introduced in Greater Vancouver and Greater Toronto, but that legislation has not materialized so far.

500 billion reasons the BoC doesn’t want to raise rates

The Bank of Canada has plenty of reason not to raise interest rates to slow soaring house prices ― namely, it fears that higher borrowing costs will sink the many people and businesses who loaded up on debt before and during the pandemic.

The Bank launched a volley of emergency policies at the start of the pandemic, including dropping its key lending rate to near zero and buying hundreds of billions of dollars of debt ― including around $100 billion of federal government debt and billions more in Canadian mortgages ― in an effort to pre-empt what could have been a major financial crisis.

The Bank has increased its balance sheet by $500 billion since the spring, injecting this much new cash into the economy, in the form of debt owed to the Bank.

It’s not alone ― the U.S. Federal Reserve, the European Central Bank and the Bank of Japan have also put their money printing machines on overdrive.

“Without the fiscal and monetary policy actions, the economic devastation of the pandemic could have been much, much worse,” Macklem said Thursday.

Central banks have pushed down interest rates, making it more affordable for households, businesses and governments to weather the crisis. But as many experts have pointed out, this sort of “quantitative easing” causes asset prices to skyrocket.

Hence the stock market’s incomprehensible climb during the worst economic downturn in decades, and the surprising news that Canada’s average home sales prices are soaring in the middle of a pandemic.

High levels of debt make borrowers sensitive to even small changes in interest rates.

Take, for instance, the federal deficit. It’s headed for $330 billion this fiscal year, according to the Parliamentary Budget Office. At the government’s current rate for long-term debt ― a tiny 0.6 per cent ― the interest on that debt will cost $1.98 billion a year.

But if rates were to return just to their norm over the past decade ― around 2 per cent ― the interest due just on this new portion of the public debt would rise to $6.6 billion, equivalent to the entire budget of the RCMP for a year.

Many households and businesses are under greater financial strain than that. Macklem, in his speech, noted that one in five Canadian mortgage borrowers don’t have enough cash to cover two months’ worth of house payments.

For this reason, Macklem says the Bank will “watch for signs that housing markets are being driven higher by speculation that prices will keep rising. And we will watch whether people buying houses are taking on outsized debt relative to their income.”

But when it comes time for action, the Bank’s message will be “Over to you, Mr. Trudeau.”

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