Is a Canadian credit crunch in the cards?

The central bank sees an economic growth story, but it might not be so sustainable

Is a Canadian credit crunch in the cards?
The Bank of Canada’s (BOC) hawkish turn was hinged on one basic premise: previous cuts have done their job, and the economy is strong enough for the central bank to withdraw some of its monetary policy stimulus. But a recent commentary from BlackRock Canada suggests that things aren’t so simple.

According to Managing Director and Head of Canadian Fixed Income Aubrey Basdeo, the central bank’s confident outlook is supported by several factors, including household spending, broadening growth across regions and industries, and anticipated contributions to GDP from exports and business investment.

“All of that is consistent with our relatively long-standing economic outlook for Canada,” Basdeo said. “In Canada, economic growth has been robust, and in fact has led the G7 for the past two quarters.”

However, he also noted that the central bank’s moves to increase rates could kick down one of the main points in its growth story. “Importantly, household spending has been and will likely continue to be the prime growth mover,” Basdeo said. “Rates, however, are rising, and the [BOC] has acknowledged that the economy’s response to rate hikes is likely to be very different than in the past.”

He noted that the economy, particularly the real-estate market, is exhibiting greater sensitivity “to higher rates now than at any other time in recent history.” Based on that, he says the firm expects consumer spending to soften as debt payments increase. Residential investments are also anticipated to cool down, which will impact other spending areas connected to housing.

Basdeo also noted that Canadian households are already highly leveraged, making them more sensitive to higher rates compared to a decade ago. He acknowledged, however, that Canadian borrowers currently have low delinquency rates and decent credit scores, averaging at “a healthy 720,” which should decrease possible negative repercussions on the credit front.

Still, the current trend in inflation could be an additional cause for caution. “Currently, the Bank’s core measure of inflation is running at 1.4% year-on-year, well below the Bank’s 2% target,” he said. “If this trend persists, it is likely additional hikes could serve to further suppress inflation unduly should consumption growth slow markedly.”

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