OTTAWA - An overbuilt and overpriced condominium market is posing a risk to Canadian households, banks and the economy in general, the Bank of Canada warned Thursday in its latest review of the health of the country's financial system.
The central bank particularly singles out the Toronto condo market, which it notes continues to carry a high level of unsold high-rise units in the pre-construction or under construction phases.
Overall, the bank says it believes both global and Canada financial conditions have improved somewhat despite the subdued pace of the economic recovery.
In Canada, the growth in household credit has continued to slow and has fallen broadly in line with growth in disposable income, and overall activity in the housing market has moderated.
But it is still worried about the housing market, and particularly condos in Toronto.
Story continues below slideshow
"If the upcoming supply of units is not absorbed by demand as they are completed over the next 12 to 30 months, the supply-demand discrepancy would become more apparent, increasing the risk of an abrupt correction in prices and residential construction activity," it says.
"Any correction in condominium prices could spread to other segments of the housing market as buyers and sellers adjust their expectations."
That could start what it terms a negative feed-back loop. A plunge in house prices bites into net household worth, shatters confidence and consumer spending, impacting income and job creation.
"These adverse effects would weaken the credit quality of bank's loan portfolios and could lead to tighter lending conditions for households and businesses. This chain of events could then feed back to the housing market, causing the drop in house prices to overshoot."
The warning comes as Statistics Canada reported the price of new homes nationally rose 0.2 per cent in April from the previous month. Economists had expected an a 0.1 increase.
The bank cautions that its unravelling scenario is not what it is predicting. In fact, it still expects the correction in the housing market to go smoothly.
"Nevertheless, simple indicators continue to suggest some overvaluation in the housing market; house prices are high relative to income and housing affordability could become a concern when interest rates begin to normalize," it adds.
The continuing highlighting of household imbalances, despite noting that the risks have in fact lessened somewhat in the past six months, suggests the central bank remains worried that with interest rates likely to continue at near emergency low levels, the dangers of something going off the rails intensifies.
Last week, the OECD singled out Canada as one of three nations in the advanced economies with the most overvalued housing market, adding that despite that elevated status, prices continue to rise.
Any number of shocks could send Canada's house of cards tumbling, the bank says, particularly higher borrowing costs that pinches households already carrying record high levels of debt.
Even an intensifying of the ongoing euro-area financial crisis, which could occur, the bank says, because there are signs Europeans are becoming weary of austerity and reforms.
"If the situation were to occur ... trade and financial linkages could spread the shock to other regions, leading to a more severe and protracted reduction in global demand. This in turn could trigger a sharper correction in Canada's housing market."
The bank says even if the worse does not happen, it will take years for Canada's housing imbalances to right themselves.