The expected, gradual rise of interest rates over the next few years is poised to push the financial vulnerability of indebted Canadian households well above levels seen in the last three decades, warns a new analysis.
A report released Tuesday by the parliamentary budget officer predicted that higher rates expected in the coming years will leave households exposed to economic shocks at "levels beyond historical experience."
The study comes amid concerns that rising debt levels – largely fuelled by surging housing prices – have made households increasingly vulnerable to events like a severe recession that trigger job losses or higher-than-expected interest rates.
Rising rates threaten to make it harder for Canadians to pay down their debt, the PBO said.
The country's debt service ratio – the household debt payments relative to disposable income – has already climbed above the historical average seen between 1990 and 2017, said Mostafa Askari, the assistant parliamentary budget officer.
"That by itself has to be considered alarming because obviously it means that the households will be more vulnerable over time to any kind of shock to the economic system," Askari said.
Askari said the ratio will continue its ascent when the rock-bottom borrowing rates start rising. Some analysts predict the first hike to come as early as this year.
Indebted households will no longer enjoy the offset of lower interest rates on their debt payments, he noted.
"We project that household debt-servicing capacity will be stretched even further over the medium term as interest rates return to more normal levels," the report said.
As the economy strengthens, the Bank of Canada has been signalling that it's moving closer to hiking its benchmark interest rate. Its trendsetting rate has been locked at 0.5 per cent since 2015 and hasn't seen an increase in seven years.
The PBO is projecting the central bank's rate to rise to three per cent by mid-2020.
It predicts the household debt service ratio to reach 16.3 per cent in 2021, which would be nearly 3.5 percentage points higher than the 12.9 per cent average seen between 1990 and 2017.
The debt service ratio has crept upwards over the last two years to hit 14.2 per cent early this year, the report said.
"Based on PBO's projection, the financial vulnerability of the average household would rise to levels beyond historical experience," it said.
"Households that are required to devote a substantial portion of their disposable income to service their debts are vulnerable to adverse income and interest-rate shocks, and are more likely to be delinquent in their debt payments."