May 17, 2017 / 7:36 PM / 2 months ago

Pressure builds on Bank of Canada to tackle house prices

4 Min Read

FILE PHOTO: Construction equipment is parked at the bottom of a pit on the site of a new condominium complex off Redpath Avenue in Toronto, Ontario, Canada April 1, 2017.Chris Helgren/File Photo

TORONTO (Reuters) - Pressure is building on the Bank of Canada to signal an interest rate hike, as some economists fret about a rapid rise in domestic house prices after eight years of rock bottom borrowing costs.

The central bank has kept its policy rate at or below one percent since 2009 in an effort to stimulate an economy that had struggled to gain traction since the global financial crisis. But house prices have more than doubled over the period in the two biggest markets, Toronto and Vancouver, and a closely watched measure of a country's vulnerability to debt, the household debt-to-income ratio, has risen to a record high 167 percent.

Economists worry that leaving low rates in place for too long could encourage too much borrowing and leave the economy vulnerable if growth slows or house prices drop, while investors have seized on recent hints of risks to financial stability.

"The way you reduce the pace of credit growth and eventually solve the problem of high leverage is by having higher rates, not by keeping rates low," said Carlos Capistran, ‎head of Canada and Mexico economics at Bank of America Merrill Lynch.

"It is painful for the economy when you start tightening but you have to do it at some point. Otherwise, leverage is going to keep increasing."

Bank of Canada Governor Stephen Poloz said this month that 30 percent gains in Toronto house prices are not sustainable and have been driven in part by speculation. But the central bank has favoured macro-prudential tools, such as steps taken by federal and provincial governments that crack down on speculation and tighten mortgage lending rules, to promote financial system safety.

The central bank declined to comment, saying it is in blackout ahead of its interest rate decision next week.

To be sure, the latest data showed Canadian home resales fell in April, in a sign the government moves are helping to rein in runaway property prices. But it is unclear how long the adjustment will persist.

"It is time for the Bank of Canada to at least signal their intent to take back the two emergency rate cuts in response to the energy meltdown," said David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates Inc.

The central bank cut rates twice in 2015 after a plunge in the price of oil, one of Canada's major exports, to leave its policy rate at 0.5 percent, a level that Rosenberg said is out of place with recent strength in the domestic economy.

Economists say Canada could grow as much as 4 percent in the first quarter after a solid expansion in the second half of 2016. But the market has largely given up on prospects for a rate hike this year as the central bank downplays the sustainability of recent stronger-than-expected growth.

"They (the Bank of Canada) still think a weak Canadian dollar is good for the economy and they are going to keep talking down the loonie, talking down the economy," said Krishen Rangasamy, senior economist at National Bank Financial.

But the Bank of International Settlements' early warning indicators for financial crises signal vulnerabilities in Canada, while Moody's last week downgraded the country's major banks and investors are wary about how the troubles of alternative lender Home Capital Group Inc could affect the country's real estate market.

Canada's financial stocks have fallen to a five-month low and the Canadian dollar recently hit its weakest in 14-months near C$1.38 to the greenback as bearish bets on the currency by speculators shot to a record high.

"By keeping interest rates low you are setting yourself for problems down the road. For example, financial stability risks, and that's something that is very concerning to us," Rangasamy said.

Reporting by Fergal Smith; Editing by Denny Thomas and Chris Reese

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