The Bank of Canada just went all of 2019 without an interest-rate move. The way it’s being hemmed in by Canada’s high household debts, it could go all of 2020 without one, too.
There’s no question that the country’s heavy consumer debt load poses a major barrier to the central bank cutting its key rate from the current level of 1.75 per cent. The bank has said so, loudly and clearly, since late October. That’s when its governing council debated – and rejected – making a cut as “insurance” against the then-mounting risks of an escalating U.S.-China trade war and a global economic downturn.
The risks of compounding Canada’s already substantial debt problem by making borrowing even cheaper, it concluded, outweighed the benefits of giving the economy a shot of adrenaline with a cut.
The Bank of Canada has been warning for years about the potential threat of high household debts to Canada’s economic and financial stability. And it’s keenly aware that a decade of historically low interest rates has been a key catalyst in this worrisome debt buildup. As Bank of Canada deputy governor Timothy Lane cautioned in a speech in early December, in explaining the bank’s decision to hold its rate steady while most of the world’s major central banks have been cutting, “lowering rates further could make those [household] vulnerabilities worse.”
Which is not to say that the Bank of Canada wouldn’t cut rates under any circumstances. But it certainly indicates that household debts have raised the central bank’s bar – substantially – on cuts.
While most of the talk in the past few months has been to cut, or not to cut, there are signs that household debts will be an impediment to the Bank of Canada when the time comes to consider raising rates, too. That evidence comes from Canada’s rising consumer insolvencies.
Figures from the federal Office of the Superintendent of Bankruptcy Canada show that insolvencies have been on the rise all year. In October, they reached their highest level since 2009. Consumer insolvencies have led the charge, up 13.6 per cent year over year.
What’s particularly troubling is that this is coming in the absence of any meaningful economic downturn. Employment rates are high. Wages are growing faster than they have in years.
“Obviously, this isn’t the typical cyclical climb in household credit stress, which comes when a recession leads to wide-scale job losses and, as a result, defaults on funds borrowed by those with dented incomes,” Canadian Imperial Bank of Commerce economists Benjamin Tal and Avery Shenfeld said in a Dec. 18 research report.
They believe that the rising insolvencies are linked to the Bank of Canada’s three rate hikes in 2018 – hikes that have worked their way into household balance sheets over the past year. The clues lie in the types of debt that are fuelling the insolvency rise. Leading the way are home-equity lines of credit (HELOCs) and unsecured lines of credit – debts whose interest rates reset automatically with changes in lenders’ prime rates, which move in lockstep with the Bank of Canada’s policy rate.
In contrast, credit cards – where interest rates have held steady – have not seen a rise in delinquent debts and writeoffs. Similarly, mortgage debt – which generally resets to rate changes much less frequently, and which benefited from lower rates this year amid declining global bond yields – did not come under the same kind of pressure.
The Bank of Canada has been saying for the past couple of years that the higher debts make consumers, and the economy as a whole, more sensitive to rate changes than in previous economic cycles. The central bank even incorporated this heightened sensitivity into its economic analysis and forecasting models. But until it started raising rates, it hadn’t seen the phenomenon in action.
“If raising the [Bank of Canada’s] overnight rate to only 1.75 per cent could set off a climb in insolvencies, before any major job losses have been seen, it’s clear that taking rates to anywhere near what was historically neutral, or even where some models might currently put neutral, could prove to be overkill,” Mr. Tal and Mr. Shenfeld wrote.
The prospect of rate hikes might be closer than you think. With the risks around trade and the global economy subsiding, the Canadian economy running near full capacity and inflation inching above the Bank of Canada’s 2-per-cent target, it wouldn’t take much of a pickup in growth for a rate hike to enter the conversation, possibly toward the end of 2020.
But the dangers associated with household debt could well cause the Bank of Canada to be as reluctant with hikes as it has been with cuts. Barring a dramatic change in the economic outlook, this could spell another year where rates end just where they started.