12 Mar The BoC’s household debt conundrum: Rate hikes or regulation?
Economists are pretty much in agreement that the Bank of Canada, while still maintaining its interest rates at a stimulus-level 1.00%, also adopted a more hawkish tone in its latest comments.
Mark Carney, governor of the central bank, highlighted an improving global economic outlook while also noting that household debt burdens have become the biggest domestic risk. Enough grist for the mill, certainly, for economists to begin speculating about Mr. Carney accelerating his plan to eventually raise rates again. At some point in the future. Possibly. (You know how it is).
While quite subtle, the associated rate statement signalled a possible lack of patience with the status quo,” Mark Chandler, head of Canadian fixed-income and currency research with RBC Capital Markets, said in a note Friday.
However, the real question is what Mr. Carney plans to do about the growing debt problem.
“Over the past couple years, the presumption had been that household debt accumulation was largely a sector-specific problem tied to housing prices and associated mortgage credit growth,” Mr. Chandler said.
Problem was, direct measures introduced in the past two years, including lowering the maximum amortization period to 30 years and requiring borrowers to qualify for at least a five-yeare fixed-rate term even if they choose a lower rate or term, have been largely ineffective at pushing the debt needle back.
“One can argue that additional capital requirements should be part of the solution (as per Basel III) but financial institutions are already scrambling to build core capital requirements required under the new rules,” he said. “If the macro-prudential tool is unavailable, the burden could (or should) fall to monetary policy.”
On the other hand Sheryl King, Canada economist with BofA Merrill Lynch, argues against a rate hike due to its likely negligible impact on bond yields, which are used by the banks to determine mortgage rates. Bond yields have been weak ever since investors, fearful of roller-coaster equities in the wake of the financial crisis, have been flocking to fixed income for guaranteed yield.
“The more effective and direct policy tool for the mortgage market, in our view, is tighter regulation,” she said.
For example, if Canada further reduced its maximum amortization period to 25 years from 30, it would be the equivalent of a 95 basis-point rise in the five-year fixed rate mortgage.
The U.S. Federal Reserve, which faced a similar conundrum under the stewardship of Alan Greenspan between 2004 and 2006, was only able to achieve similar results through a 400 bps increase in the rate, she said.
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