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Development of new town houses in Toronto proceeds on May 19, 2021.Christopher Katsarov/The Globe and Mail

A new study from the office of the Parliamentary Budget Officer suggests that Canada’s housing price surge represents a big problem for a relatively small portion of the population. But in terms of the potential implications for the Canadian economy, the concentration of that vulnerable group may be a bigger issue than its size.

The PBO’s report, issued last week, analyzed affordability of home purchases by comparing prices with borrowing capacity (based on average incomes and mortgage rates) in each of the country’s 11 biggest census metropolitan areas, or CMAs. It found that in four of those cities – Toronto, Ottawa, Hamilton and Halifax – average house prices at the end of 2021 were more than 50 per cent above the average capacity to affordably borrow. In three other markets – Vancouver, Montreal and Victoria – prices were 30 per cent to 45 per cent above affordability levels.

Further, the study calculated that in Toronto, Vancouver, Hamilton and Victoria the average mortgage debt-service ratio – the proportion of monthly gross income eaten up each month by mortgage payments – topped 39 per cent in December, a key upper threshold used by lenders and by Canada Mortgage and Housing Corp.

“While approximate in nature, these results suggest that household financial vulnerability is elevated in several CMAs for households that have recently purchased homes,” the report concluded.

Houses highly unaffordable in many Canadian cities, PBO says

Let’s consider what share of the population that actually represents. Last year, about 4 per cent of Canadian households bought a home. And, as the PBO report notes, not all parts of the country have been hit equally. Some large cities, such as Calgary, Edmonton and Winnipeg, don’t appear to have affordability issues at all.

But the cities that are acutely affected are also some of the country’s biggest economic engines. The Toronto metropolitan area, as one very big example, accounts for about one-fifth of Canada’s gross domestic product. The four cities that the PBO identified as reaching excessive debt service ratios represent nearly one-third of GDP.

What’s more, interest rates are a key part of the affordability equation – when they go up, the borrowing capacity for the average household goes down, and the current high home prices will look even less affordable. With the Bank of Canada poised to raise rates multiple times over the next few months as it battles inflation, the strains on buyers in these markets will only get worse.

And while 4 per cent of the population might not sound like a big group, it’s certainly big enough to have a powerful effect on economic activity. (Consider, for example, how big a deal it is for the economy when an additional 2 per cent or 3 per cent of the population becomes unemployed.)

At very least, it implies a potential significant constraint on consumer spending in some major economic regions, as those recent buyers grapple with their mortgage expenses. As such, it poses a headwind to growth. It also has the potential to deepen the next economic slowdown, as this group will be particularly vulnerable to financial stress in such a slump.

This issue is certainly on the radar of the Bank of Canada as it speeds toward rate tightening. The central bank is almost certain to raise its key rate in its next scheduled policy decision, on March 2, and looks likely to follow that up with several more increases over the rest of the year.

Quite apart from the impact that higher rates will have on homeowners who opted for variable-rate mortgages (their mortgage costs will rise along with the bank’s key rate), the central bank will need to watch closely how consumers respond to rising rates. For households under the strain of high mortgage debt in key markets, we can reasonably expect excess caution as rising rates tap the brakes on the economy and increase consumer borrowing costs.

Immigration is rising. So will housing prices – unless we start building a lot more homes

Paul Beaudry, one of the Bank of Canada’s deputy governors, summed up the risks in a speech last November:

“Financially stretched households have little breathing room to absorb any disruption to their income. A job loss could force many to drastically cut their spending to keep servicing their debt,” Mr. Beaudry said. “A drop in housing prices could also reduce household consumption because many people use their home as collateral to secure a home equity line of credit or refinance their mortgage. And an increase in unemployment or drop in house prices would have worse effects on the economy today because both debt levels and the share of wealth concentrated in housing have risen over time.”

The bank has frequently pointed to the massive increase in overall household savings during the pandemic as a potential source of fuel to maintain strong consumption over the next couple of years, and as a reason to believe that Canadian households are well equipped to sustain unforeseen bumps in the economic road. But the rapid deterioration in housing affordability, especially in the massive economic region of Toronto, has become a force leaning against that.

Even if the portion of the population that is vulnerable remains relatively small, the degree of vulnerability certainly looks to be growing – and its concentration in some of the country’s biggest economic engines cannot be ignored.

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