The unprecedented rise in consumer debt means the Bank of Canada’s rate-hiking cycle is already the most severe in 20 years and further increases will have far graver consequences than conventional analysis shows, Macquarie Capital Markets Canada Ltd. said.
Assuming just one further rate rise, the impact would be 65 percent to 80 percent as severe as the 1987 to 1990 cycle, according to Macquarie, which took into account five-year bond yields, household debt and home buying. Canada’s housing market slumped in the early 1990s after that rate-hike cycle and a recession.
“The Canadian economy has experienced an unprecedented period of hyper-leveraging,” analysts including David Doyle wrote in the note released Thursday. According to Macquarie, this is underlined by the fact that:
About 30 percent of nominal GDP growth has come from residential investment and auto sales over the past three years. This is about 50 percent greater than what has been experienced in similar prior periods.
The wealth effect from rising home prices has driven nearly 40 percent of nominal growth in gross domestic product over the past three years, about two to four times the amount experienced previously when the BoC was hiking rates.
Even as this has occurred, fixed business investment and exports have struggled, limiting the ability for a virtuous domestic growth cycle to unfold. This again is in sharp contrast to similar periods in the past when these were accelerating.
New mortgage stress-test rules will also have a larger impact than estimated, Macquarie said. The new rules in isolation are expected to reduce buyers’ maximum purchasing power by as much as 17 percent. That jumps to about 23 percent after incorporating the rise in mortgage rates since mid-2017, according to the note.
Governor Stephen Poloz has indicated high household debt could make the slowing impact of rate hikes harsher, and that the impact of 2017’s increases will not be fully clear for 18 months, Doyle said.
“When taken together, these observations mean the Bank of Canada is proceeding with hikes despite uncertainty surrounding the severity of tightening performed so far,” Macquarie writes. “This elevates the risk of policy error.”
Macquarie expects only one more rate hike in either April or July.
By Natalie Wong Bloomberg News