Canada's Housing Bubble

Jun 09, 2010 Jonathan Chevreau opinion.financialpost.com

If you thought the recent quarter-point rise in the Bank of Canada’s key lending rate was bad news, you might want to consider the “glass half full” arguments of Gordon Pape in the current edition of his Internet Wealth Builder [fourth item down.]

Pape lists five reasons why rising rates can be viewed as positive. In a preamble, he notes that the malaise in Europe has so far impacted Canada only with a modest drop in commodity prices and some tightening of financial conditions. But in our modern interconnected world, Pape thinks Canada’s 6.1% first-quarter growth rate is “unsustainable.” Our dovish stance on rates amounts to a policy of “more rate hikes if necessary but not necessarily more rate hikes.”

Here’s Pape’s reasons for viewing this as good news:

1.) It puts borrowers on notice

The availability of effectively “free money” has caused homeowners to take on more debt than is healthy. The 0.25% hike has symbolic value in that it may cause people to think twice about taking on debt that may become increasingly onerous in a few years.

2.) It will help to cool the housing market

If there’s a housing bubble here, it’s regional in nature: particularly in Vancouver and some parts of Toronto.

Even modest rate hikes should help to restore stability in our overheated cities.

3.) Cash will earn a little more

With $50 billion parked in money market mutual funds, Canadian savers are earning almost nothing: 0.07% on average in such funds.

Even that pathetic figure was only achieved because many fund companies dramatically reduced or eliminated their management fees. A quarter-point increase on short-term money is significant in this context.

4.) Bonds will perform better than expected

There’s been plenty of jump-the-gun articles in the press about a looming bond bear market, since a series of rate hikes would cause bond prices to fall.

Now it appears that won’t happen. Rates will rise much more gradually which means the negative impact on bond prices will be muted.

As of last Thursday, the DEX Universe Bond Index showed a gain of 2.51% for 2010: higher than most would have expected in January and also ahead of the 0.6% rise for the S&P/TSX Composite Index year-to-date.

5.) Inflation is not a major threat

By late April, the annualized CPI was 1.8% while the BOC’s core rate moved from 1.7% in March to 1.9%. That’s closer to the Bank’s inflation target of 2% but its statement underplays this,  citing “significant excess supply in Canada” and “the uneven global recovery.”