The International Monetary Fund has cautioned Ottawa to go easy on its deficit-fighting zeal, in light of the growing risks to Canada's economic health.
In a new country assessment released Friday by the powerful global financial institution, the IMF said it believes the federal government remains "essentially on track to achieving its balanced-budget target in fiscal 2015/16, despite lower oil prices." However, it said, "Federal authorities should consider adopting a neutral stance, given past consolidation gains and downside risks to growth."
"Such a stance would still be consistent with achieving the longer-term goals on public debt reduction," it said.
In the annual report, which reviews Canada's economic outlook and financial stability, the IMF also estimated that Canada's housing market is now overvalued by "between 7 and 20 per cent" on a national basis, "although with important regional differences." That suggests that home prices have become more overvalued from a year ago, when the IMF estimated that prices were "about 10 per cent" above what would be justified by market fundamentals.
The IMF noted that "low and declining interest rates" have continued to fuel the Canadian housing market, "although there are some welcome signs of cooling, especially in overheated markets." It also said that despite the overvaluation, it remains confident that Canada's housing sector will achieve a "soft landing," as the anticipated rise in U.S. interest rates this year put upward pressure on Canadian rates, and the slumping oil market weighs on Canadian growth and investment, including residential investment.
"Higher interest rates and weaker terms-of-trade prospects would temper housing demand," it said.
Earlier this month, in its World Economic Outlook update, the IMF trimmed its growth forecasts for Canada to 2.3 per cent in 2015 and 2.1 per cent in 2016, down from its previous projections of 2.4 per cent for both years. It estimated that the Canadian economy grew 2.4 per cent in 2014.
Given the slowing growth outlook and the impact of the oil shock on the Canadian economy, the IMF gave its thumbs-up to the Bank of Canada's decision last week to trim its key interest rate to 0.75 per cent from 1.0 per cent – despite the potential exacerbation of the overshoot in housing.
"The bank's policy action is in line with [IMF] staff advice to use monetary policy space should adverse shocks intensify, given the deeper drop in oil prices," the report said.
"Overall, maintaining monetary accommodation along with gradual fiscal consolidation at the general government level would be conducive to achieving a growth composition with stronger exports and, thereby, investment in the economy," it said.
It suggested further tightening of mortgage lending rules might be a more appropriate tool than monetary policy for keeping housing risks in check.
"Targeted macro-prudential policies would help address housing sector vulnerabilities as needed," it said.