IMF casts nervous eye on Canadian housing market

KEVIN CARMICHAEL - The Globe and Mail

Canada’s average home price is about 10 per cent higher than models suggest it should be, posing a “vulnerability” to the country’s economic outlook because a drop in prices would be a blow to already highly indebted consumers, the International Monetary Fund warns in a new report.

With household debt at about 150 per cent of disposable income, the domestic spending boom that helped Canada weather the financial crisis already is at its limits.

A collapse in housing prices would be a serious blow to the economy because of the link between consumer demand and household wealth.

The IMF, in its annual report on Canada’s economy, estimates that a 10 per cent decline in housing prices could result in a 1.1 per cent drop in personal consumption, excluding durable goods, which would correspond to loss 0.5 per cent loss in gross domestic product.

“Adverse macroeconomic shocks, such as a faltering global environment and declining commodity prices, could result in significant job losses, tighter lending standards, and declines in house prices, triggering a protracted period of weak private consumption as households reduce their debt,” the IMF says in the report. “The effects on economic growth could be exacerbated by weaker external demand and slowing construction activity.”

This isn’t the IMF’s base case for Canada. The fund is laudatory of the policies of the Finance Department and the Bank of Canada, and predicts the country will continue to manage relatively well in a turbulent global economy. The IMF predicts Canada’s economy will slow to annual growth rate of about 2 per cent next year from 2.2 per cent in 2011 due to weaker demand for exports.

But it’s the IMF’s job to point out what could go wrong.

Canada’s position in world trade has weakened, the primary evidence being a persistent trade deficit after years of enjoying a trade surplus. This is primarily the result of weaker demand for automobiles and lumber in the United States, but the country also is paying the price for doing too little to enhance productivity and seek out new markets, the IMF said. Canada’s growth prospects over the near term are limited as a result, the fund says.

The IMF’s warnings on the housing market and household debt echo those of the Bank of Canada. The fund’s report amplifies the stakes by quantifying what could go wrong if the housing market slips. An external shock such as an abrupt drop in commodity prices that triggered a decline in house prices by 15 per cent, accompanied by a severe downturn in construction, could result in a 2.5 per cent loss in GDP over two years, the IMF says.

Policy makers should continue to watch developments in the mortgage market closely, the fund says. Lending for homes has slowed, but still is a growing at a “robust” pace of almost 7 per cent, the report says. Finance should be read to take stops to slow borrowing further if home lending continues to expand excessively, such as larger down-payment requirements for mortgages and demanding lower debt service-to-income ratios, the IMF says.