Mark Carney can taste victory in his long-running battle against a housing bubble.
For the first time in a year, the Bank of Canada on Wednesday signalled comfort that Canadians are getting the message about taking on too much mortgage debt, a shift in behaviour that will allow policy makers to keep short-term interest rates low amid signs of deteriorating growth.
In its latest policy statement, the central bank removed language that suggested it would raise rates, if necessary, to curb a surge in household borrowing to record levels. Instead, the bank cited evidence that consumer debt is now growing at the same rate as incomes as it explained its decision to leave its benchmark lending rate at 1 per cent for the 30th consecutive month.
For more than two years, the Bank of Canada Governor and other policy makers have warned against an unsustainable rise in debt, much of it caused by real-estate prices that have gone up more than 80 per cent in the past decade in major urban markets.
The International Monetary Fund and numerous economists have described an overheated housing market as one of the biggest risks to the Canadian economy, and last year, Finance Minister Jim Flaherty clamped down for the fourth time on the rules for mortgage insurance to discourage home buyers from borrowing more than they can handle.
The change in tone from the bank suggests that, in Mr. Carney’s mind, the household-debt risk has eased, and the bigger concern is sluggish growth and weak business investment. Canada’s economy grew at a meagre annual rate of 0.6 per cent in the fourth quarter, Statistics Canada said last week, markedly slower than the central bank had predicted in its January outlook.
Canada’s dollar fell after the statement was released, as traders locked in bets that the Bank of Canada will leave interest rates unchanged until well into 2014, an extraordinary duration that reflects the struggles of policy makers everywhere to coax their economies back to pre-crisis levels of growth.
The bank’s threat to raise rates had been driven solely by concerns about household borrowing, said Sébastien Lavoie, assistant chief economist at Laurentian Bank in Montreal – not by worries about inflation. With that threat removed, “companies and consumers can go ahead and plan on rates not being materially different in a year than they are right now.”
That kind of clarity is new, and could spark an increase in business investment, which central bank officials have said recently is essential to faster economic growth in 2013.
Executives reinvest their companies’ profits when they believe comfortable economic conditions, including borrowing rates, will remain stable.
But for the better part of two years – at first informally in speeches, and later formally in official central bank communications – Mr. Carney sought to keep executives and households just a little off balance as he tried to stimulate the economy without unleashing the sort of debt-fueled spending binge that brought down the U.S. economy and ushered in the Great Recession.
Mr. Carney hasn’t been acting alone. Mr. Flaherty’s changes to the rules for mortgage insurance eliminated government-backed mortgages that could be paid off over periods longer than 25 years.
Canadians are borrowing less, and as a result, housing prices are moderating, and the amount of real-estate activity has dropped. Sales of existing homes in Toronto dropped 15 per cent in February from a year earlier, and in Vancouver, they plunged 29 per cent, marking the second-weakest February since 2001. Nationally, home sales have been declining steadily, year over year, since the middle of last year, prompting some real-estate agents to grumble that Ottawa has gone too far.
“The market would have corrected on its own,” said Phil Soper, chief executive at Toronto-based real-estate company Royal LePage.
To be sure, one of the reasons Canada’s economy is slowing is that no growth engine has taken over from the housing market. The Bank of Canada said on Wednesday that it anticipates “solid” business investment this year, but, so far, companies are expressing caution. Exports are suffering from tepid demand and a stronger dollar, and the central bank concedes they won’t reach pre-crisis levels until the latter half of 2014.
But of even greater concern to the Bank of Canada is inflation, which, instead of heating up, is sliding uncomfortably close to disinflation, or a state of stagnant price increases, which could squeeze profit margins and suck the life out of the economy.
The central bank aims to keep annual inflation at 2 per cent, and is comfortable so long as prices advance within a range of 1 per cent to 3 per cent. In January, the consumer price index slumped by 0.5 per cent, forcing policy makers to acknowledge on Wednesday that inflation is “somewhat more subdued” than they were expecting.
“You can’t ignore that,” said Michael Gregory, senior economist at BMO Nesbitt Burns in Toronto, who predicts the Bank of Canada will leave its benchmark unchanged until the third quarter of 2014. “If you don’t address inflation, you risk undermining the credibility of your inflation target.”
Editor's Note: An earlier version of this story incorrectly stated that the consumer price index, or CPI, slumped by 1 per cent in January from a year earlier. The CPI was in fact 0.5 per cent higher than in January 2012. Core inflation, which subtracts volatile prices such as gasoline and food from the basket of goods measured by the CPI, slowed to an annual rate of 1 per cent in January.