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Today's high house prices could make the next recession problematic: CIBC report

House prices can't climb much faster than incomes forever but would Canadians fear or cheer for a correction?

TORONTO, April 13, 2017 /CNW/ - A sharp pullback in house prices is unlikely to trigger an economic downturn, but today's high house prices and larger mortgages could make the next recession, when it comes, longer and deeper, finds a new report by CIBC Capital Markets.

"Given larger average mortgage principals that have been needed to pay for more expensive housing, the Bank of Canada's ability to raise rates during the upswing of the cycle will be severely constrained," says Avery Shenfeld, Chief Economist, CIBC Capital Markets, who co-authored the report, Would We Fear or Cheer a House Price Correction? with senior economists Andrew Grantham and Nick Exarhos. "A two per cent rise in mortgage rates would be fairly gentle by past tightening cycles, but would raise monthly payments by roughly 25 per cent on a conventional five-year mortgage."

Insured mortages have left a cushion to ensure that the borrower would still be solvent, but that doesn't mean that there wouldn't be "a major impact" on their non-housing consumption, the report says.

Because it's been unable to hike rates very much in an economic upswing, the Bank of Canada would find itself left with a lot less room for conventional rate cuts to boost the economy when a recession eventually hits, the report says. That and any spillover from falling house prices on consumption during the recession would be problematic for battling the next recession when it comes.

Mr. Shenfeld says that history, and theory, suggest that a retreat in house prices shouldn't trigger an economic downturn despite what happened during the U.S. sub-prime mortgage crisis.

Canada is not necessarily on the verge of a house price correction, he says, noting that "gloomy forecasts were just as common, and wrong, three years ago." 

"But there are reasons why today's high house prices and larger mortgages could make the next recession, when it comes, more problematic."

Economy-wide consequences of a house price correction would largely depend on what triggered it in the first place, such as an interest rate hike or mortgage quality, the report says.

"The Bank of Canada is only going to be raising interest rates because the economy is doing well. So if house prices were falling in that environment, as might be the case, it would be circular to say that the economy would be in ruins," Mr. Shenfeld says.

Global inflation pressures are generally muted so an error on the side of too much tightening seems an unlikely scenario to fret about, the report says.

Mortgage quality, one of the triggers for the U.S. housing crisis, is less of an issue in Canada due to tighter control over the vast majority of mortgages that come from regulated institutions, the report says. Further, looking at aggregrate debt-to-income ratios does little to help the analysis.

"What matters is who has the debt and their specific income," says Mr. Shenfeld. "Should house prices correct for any other reason, the banking sector would lose the top-line revenue growth tied to the climb in nominal mortgages outstanding … but there does not appear to be any equivalent fragility that the U.S. system faced during its meltdown."

Beyond a recession or rate shock, house prices could also fall due to the weight of their own gravity or "what some would call an exogenous bursting of market confidence," he says.
However, major retreats are actually hard to find in Canada or abroad in the absence of at least some interest rate pressure or a recession as a trigger.

Housing prices in Vancouver dipped roughly 15 per cent in 2012, a year of stable rates, and yet the regional economy seemed to survive it unscathed, the report says. "While there was some slowing in retail sales, GDP growth was little changed compared with the year earlier," Mr. Shenfeld says.

In B.C. and Ontario in 2015, the last year detailed data is available, housing meant the difference between enjoying GDP growth of 3 per cent and 2.5 per cent, respectively, rather than being stuck at a moderate 1.7 per cent pace, the report says.

"Where things get interesting is in the potential spillovers into consumption, a much larger component of GDP than housing itself," says Mr. Shenfeld.

The report examined the data to determine whether, either nationally or provincially, rising house wealth is showing up in more borrowing and consumption and less saving, and finds that the savings rate has been trending sideways while consumer credit growth, including home equity lines, has also been "quite tame," running in real terms at well below historical norms. As well, savings as a share of income is higher than it was in the 2008 to 2014 period.

"Add it all up, and a correction in house prices in Ontario and B.C. might well lop off a few decimal places from growth through softer consumer spending, in addition to a direct hit to residential construction," says Mr. Shenfeld.

"Housing matters, but a correction that wiped off the past couple of years of gains in the hottest markets, but left the vast majority of owners with substantial equity wouldn't on its own be a national recession scenario," he says. "Recessions are more likely to be the cause of a house price decline, rather than the reverse."

Measures to encourage more construction today, which would help dampen price and rent inflation and lift near-term GDP growth during the building phase, could soften that future blow. 

"Not waiting too long to begin nudging rates higher would also be an ingredient in the right policy mix," he says.

About CIBC

CIBC is a leading Canadian-based global financial institution with 11 million personal banking and business clients and three major business units – Retail and Business Banking, Wealth Management and Capital Markets. CIBC Capital Markets provides integrated global markets products and services, investment banking advisory services, corporate banking, and top-ranked research to corporate, government and institutional clients around the world. Visit www.cibccm.com for more information on CIBC and CIBC Capital Markets. News releases are available at www.cibc.com/ca/media-centre/

SOURCE CIBC - Economic Research

For further information: Avery Shenfeld, Chief Economist, CIBC Capital Markets, at (416) 594-7356, avery.shenfeld@cibc.ca, or Caroline Van Hasselt, Director, Public Relations, 416-784-6699 or caroline.vanhasselt@cibc.com
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