Thoughts

June 10, 2022 | 12:56

Canadian Households: The Hangover

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Two surveys released on Thursday highlight the challenges many Canadian households are facing with inflation at three-decade highs and the proverbial punch bowl now getting snatched away.

Statistics Canada’s Portrait of Canadian Society survey found that fast-rising prices are dramatically changing consumer spending patterns. Nearly three-quarters of households said high inflation was squeezing their budget, forcing them to look for cheaper substitutes or delay spending, including for homes. Not surprisingly, lower income households are hurting the most, notably from the rising cost of essentials such as food, fuel and shelter. One fifth of households say they are likely to turn to food donations in the next six months; fewer than 2% used a food bank in a three-month period at the start of the pandemic. And this is with an unemployment rate at half-century lows.

Housing affordability is also high on the list of concerns after ballistic price gains. By our estimates, mortgage service costs on the purchase of a typical house are now as bad as in 1989, and that’s with five-year fixed mortgage rates closer to 5% than 12%. So, it’s not surprising that the survey found nearly one third of Canadians and just over half of those aged 15 to 29 are very concerned about the cost of owning or renting a house. In the six-month period before the survey, just under 40% of persons aged 15 to 39 who wanted to buy a house or rent a new unit were sidelined by the rising cost of shelter. On the bright side, if home prices do adjust materially lower, we could see some pent-up demand, notably from younger millennials.

High inflation is pushing more Canadians into hock. Just over one quarter of households borrowed to meet rising expenses in the six months before the survey. This share is higher for lower income and younger families. High inflation is also gobbling up savings, with almost one quarter of households tapping their rainy day funds to meet daily expenses.

Thankfully, households have amassed excess savings equal to nearly 20% of disposable income, by our estimates. This buffer will soften the price pain for most families, but the savings aren’t spread equally among income cohorts. According to the Bank of Canada’s annual Financial System Review, households have substantial liquid assets, largely bank deposits, but this cushion is much smaller for lower income and highly indebted households, including those who used extra savings to buy a home. The average household holds liquid assets that are 5 times greater than before the pandemic, while the figure drops to less than 2 times for highly indebted families.

Households are also sitting on big wealth gains, up just over a quarter million dollars per household, on average, in 2021 and 2022. Here too, the average masks big distributional differences. It will also fall if home prices correct lower.

The housing frenzy drove debt to all-time highs. About 19% of households owed in excess of 350% of disposable income in 2021, a record. The frenzy was due to “extrapolative price expectations”, or fear of missing out on future price gains. Investors led the mania, accounting for more than 22% of sales in late 2021, versus 19% in 2019. They also extracted increasing amounts of equity out of their appreciating investments to, yep, buy more homes. This group will be the first to pull back, and if they start selling en masse, the price correction could gain steam.

As affordability worsened, more buyers sought lower variable-rate mortgages anchored to near-zero policy rates. This adds another source of vulnerability in a rising rate climate. For all mortgages originating in 2020 and 2021, the Bank estimates that the median family will see a 30% increase in monthly payments upon renewal, assuming current market expectations for rate hikes. Those who took out a high-ratio (> 450% of DI) loan could see a 37% jump, and those with variable rates could see a 45% jump, or a whopping $1,020 per month. While most variable rate borrowers won't see an increase in monthly payments until renewal in 2025-26, about 20% will, though rising wages will ease some of the pain.

Bottom Line: While elevated wealth and savings will provide some support, over-indebted households without these two cushions will be especially sensitive to rising prices and interest rates. That’s one reason the path between a soft and hard landing is a narrow one...and Governor Macklem will have a “delicate” mission walking it.