Housing could be overvalued by 30 per cent, Bank...
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Dec 10, 2014  |  Vote 0    0

Housing could be overvalued by 30 per cent, Bank of Canada warns

But market likely headed for soft landing, and Canada’s economy shows signs of strength, governor Stephen Poloz says


The Bank of Canada says home prices could be overvalued by as much as 30 per cent, but it continues to believe the market is headed for a soft landing.

The overall risks to Canada’s economy from external factors, such as higher U.S. interest rates, slower growth in China or renewed problems in the eurozone, are lower than they were six months ago, the bank said Wednesday in its twice-yearly Financial System Review.

At the same time, Canada’s economy shows signs of strength, including higher non-energy exports and pockets of new job creation, in response to stronger U.S. growth and a falling Canadian dollar, the bank said.

“We judge that the probability of an adverse shock has eased since our June (review),” central bank governor Stephen Poloz said in a statement. “This mitigates our observation that some financial vulnerabilities appear to be edging higher, leaving our overall assessment of financial stability risk roughly the same as in June.”

The recent decline in oil prices is a concern, the bank also said, though it’s too early to tell how much of an impact it will have on the economy.

For now, lower prices at the pumps are “a Christmas gift” to consumers, Poloz said at a press conference in Ottawa, noting they will help push down Canada’s inflation rate.

Generally, lower oil prices are good for global economic growth, Poloz added.

However, since Canada is an oil-exporting nation, lower prices will initially put a dent in its growth rate, Poloz also said. The price of crude is now down by a third, which could shave a third of a percentage point off Canada’s economic growth next year, he said.

“We were predicting growth in the 2- to 2.5-per-cent area. It’s still in that zone,” he said.

The governor’s remarks came as Canada’s stock market fell the most in 17 months on worries about crude oil prices. The Standard & Poor’s/TSX composite index fell 342.78 points, or 2.4 per cent, to 13,852.95 points at 4 p.m. on Wednesday.

Oil prices have been falling on lower global demand and increased supply. West Texas Intermediate crude plunged 4.5 per cent to settle at $60.94 a barrel on Wednesday, while Brent fell below $65 for the first time since 2009.

In the meantime, high consumer debt loads and imbalances in the housing market remain a concern, the Bank of Canada said.

The bank is also concerned about the growth of higher-risk loans, including auto loans and subprime mortgages.

The greatest risk comes from the inability of stretched households to service their debt should they face a sharp decline in their incomes or a sharp rise in interest rates, which could trigger a correction in house prices, the bank warned.

The probability of this happening is low, but if it did, the effect on the economy would be severe, the bank also said.

However, the bank warned that the Toronto condominium market is at risk of an “impending overbuild.”

In general, housing market conditions today are quite different from those that led to the economic recessions of 1981-82 and 1991, Poloz said during his press conference.

In those instances, there was a rapid rise in house prices as part of a general rise in inflation, he said.

Interest rates were rising, causing an economic slowdown and recession, along with a housing correction, he said. Unemployment was also high. “None of which (factors) are present today,” he said.

In comparison, house prices recently have risen more gradually, he said, noting the market was already considered 10 per cent overvalued back in 2007. At the same time, the economy appears to be improving, he said.

However, the bank said it is also concerned about the increase in high-risk loans.

Borrowers with low credit scores now account for about one-quarter of new auto loans, the bank said. As well, riskier loan characteristics, such as longer loan terms and higher loan-to-value ratios, have become more common, the bank said.

The subprime mortgage market is also expanding, the bank said. Some 35 per cent of new uninsured mortgages written by smaller federally regulated banks since the end of 2012 could be considered non-prime, the bank also said.

Despite the bank’s “interesting and contentious” comment on house prices, Doug Porter, chief economist at BMO Capital Markets, said he see little reason to be alarmed.

The central bank’s model finds that national home prices are 10 to 30 per cent overvalued, Porter noted, adding “that’s a big range,” similar to what might be found in Australia and New Zealand.

The central bank concludes that a “soft landing is the most likely way forward” and only that there is “some risk that housing markets are overvalued,” Porter wrote.

“That final statement is pretty far from a ringing alarm bell,” Porter wrote.

Toronto Star

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