Mortgage stress test gets Poloz off the hook on interest hike: Don Pittis

New mortgage stress test rules, just before Stephen Poloz monetary policy report, offer the governor another reason not to raise rates. But that could make consumer goods more expensive.

Tougher lending rules give Bank of Canada room to manoeuvre as U.S. rates rise

The Toronto area housing market, including this suburb of Vaughan, remains hot, but some worry new mortgage rules will have a cooling effect on parts of the market that have already cooled. (Reuters)

As of today, it's tougher to buy a house in Canada. And that could have effects beyond the mortgage market.

Although the new rules will likely make first-time buyers and many in the real estate business unhappy, they will take some of the pressure off Bank of Canada governor Stephen Poloz, who gives us an update on monetary policy the day after tomorrow.

The main job of the central bank is to set interest rates at just the right level to keep the economy growing and inflation around two per cent.

Adjusting the thermostat

The theory is that lowering interest rates makes it easier for businesses to borrow and invest, creating new economic activity, using up the economy's spare capacity and creating jobs.

When the economy starts to get too hot, though, businesses begin competing for workers and other resources, driving inflation higher.
Bank of Canada senior deputy governor Carolyn Wilkins and governor Stephen Poloz are expected hold rates steady this week. Rates could stay lower for longer if the new stress test helps cool overheated mortgage lending. (Reuters)

Central banks try to use interest rates like a thermostat, lifting rates to cool the economy and lowering them to warm it up.

The trouble is that interest rates have different effects on different parts of the economy. 

While business investment has remained stagnant, the low rates set by Poloz and the Bank of Canada have contributed to a frenzy of house buying and soaring house prices, especially in Vancouver and Toronto. But using interest rates to put a lid on inflation of assets such as houses might kill off early signs of growth in other parts of the economy.

Blunt instrument

"If you're worried that housing prices are too high, the single rate that the Bank of Canada targets is too blunt an instrument," says University of British Columbia economist Tom Davidoff. 

But fortunately for the bank, governments have another mechanisms, which you may have heard mentioned elsewhere. They are called "macroprudential" tools, and International Monetary Fund boss Christine Lagarde advocated them during a September visit to Canada.

The idea is that instead of having central banks raise rates, governments create targeted laws directed specifically at one overheated sector. In the case of the mortgage stress tests, that target is new entrants into the property market who may be in danger of borrowing more than they can afford.
Raising interest rates might help to cool overheated housing markets, but they are a blunt instrument and could damage early signs of Canadian industrial growth. (Reuters)

Of course, many fear rules that kick in today and on Nov. 30 — limits on CMHC backing for non-bank lenders and making sure Canadians with insured mortgages can deal with a sudden increase in interest rates — may be too broad.

"There is the issue, of course, that not every market is necessarily hot right now, so it's possible you'll cool off some markets without needing to," says Davidoff.

Poloz has repeatedly warned about the the load of debt that Canadians are taking on. 

Will Strange, a professor at the University of Toronto's Rotman School of Business with a specialty in real estate, says that of all the possible macroprudential tools the government could have used, today's new rules are focused squarely on debt.

Spillover effect

New evidence from the U.S. last week — including the lowest jobless claims in 43 years and newly released minutes of the body that advises Fed chair Janet Yellen — indicate the U.S. central bank is about to start raising rates. U.S. rate increases have a spillover effect into Canada since people with money to invest can send it across the border to get a better rate there.

While young house hunters may be grumpy now because the law prevents them from spending as much, Strange says evidence from the U.S. shows the new rules may prevent a financial hangover that would make them much grumpier once they could no longer afford their payments.

"The people who defaulted, when we follow them in their lives after the bust of 2007 in the U.S., they have trouble getting credit, they have trouble buying houses. There's all sorts of bad things that happened after," says Strange.

Tighter lending rules do not mean people cannot buy a home, just that they have to buy a less expensive home. And Strange says that could begin to push prices lower.

Tapping the brakes?

"The question is going to be, is this tapping the brakes or is this slamming them on?" he says.

People in the mortgage business say the new rules, by directing new borrowers away from cheap non-bank lenders, are effectively pushing interest rates up in the sector the government has seen as risky.

If that turns out to be true, it is exactly the effect the Bank of Canada wants, making rates higher on personal debt but leaving them unchanged for business debt.

A slowdown in personal debt and a moderate cooling in the overheated property market will mean Poloz and his team have even more latitude to leave interest rates low, even as the U.S. begins to raise rates.

However, rising U.S. rates while Bank of Canada rates stay low will have a second spillover effect. They will tend to push the loonie down and inflation up as consumer goods get more expensive

Follow Don on Twitter @don_pittis

More analysis by Don Pittis


Don Pittis

Business columnist

Based in Toronto, Don Pittis is a business columnist and senior producer for CBC News. Previously, he was a forest firefighter, and a ranger in Canada's High Arctic islands. After moving into journalism, he was principal business reporter for Radio Television Hong Kong before the handover to China. He has produced and reported for the CBC in Saskatchewan and Toronto and the BBC in London.