12/10/2014 11:08 EST

Bank Of Canada: Housing Market Overvalued, Risky Lending Now A Problem


OTTAWA — The Bank of Canada says housing prices could be overvalued by as much as 30 per cent, but governor Stephen Poloz maintains the country's still-chugging real estate market is likely to stay on course for a soft landing.

Even with the possibility of overvalued homes, Poloz reiterated his forecast the Canadian market will unwind gradually along with the improving economy.

"We believe the economy is gathering strength, it's beginning to rebuild itself, it's going to create new jobs and income is going to go up,'' Poloz told a news conference after releasing the bank's semi-annual financial system review.

"And all those kinds of metrics are going to start to look better, and so the sustainability of the housing market will be buttressed by that.

"So, that's our main source of reassurance from this.''

The bank used a new model to crunch numbers on the potential overvaluation of the country's housing market, a calculation that suggested it may be running between 10 to 30 per cent above where it should be.

The study also found the market has been overvalued by more than 10 per cent since 2007 and has ``exhibited only a modest degree of upward creep since 2009.''

Poloz said the conditions around the ongoing rise in house prices are better when compared to the sharp real estate increases seen in the early 1980s and 1990s _ two periods followed by economic downturns.

The episodes in the 80s and 90s were accompanied by rising interest rates to address growing inflation. Those ingredients aren't present today, Poloz said.

"It's not as though we became overvalued yesterday by some number _ it's actually been building up for a really long time,'' said Poloz, who added the model also assessed the probability of a housing correction.

"That probability is actually really low compared to those other historical episodes and actually looks like it's falling.''

The bank's financial system review identified other key vulnerabilities and looming threats faced by Canada's financial system.

In particular, it pointed a finger at mounting household debt as one of the biggest weak spots in Canada's economic armour.

Earlier this month, Poloz maintained the bank's trend-setting interest rate at one per cent, where it's been frozen since September 2010.

The low rate has encouraged Canadians to accumulate piles of debt since the recession as a way to help stimulate the battered economy. Most economists and analysts don't expect the rate to budge until at least the middle of next year.

The bank's report cautioned that Canada's household debt-to-income ratio is near a record high, conditions that may have been partly fuelled by stiff competition among lenders.

The situation, it said, may have encouraged some Canadians to borrow too much and led financial entities to lend to riskier clients.

The review said 12 per cent of Canadian households are ``highly indebted.'' The bank said this percentage has been steady in recent years, but is nearly double the level in 2000.

These households carry about 40 per cent of the country's overall consumer debt load, the study found.

The bank also warned of increased risk taking in financial markets and noted other emerging threats, such as steep drops in the price of oil and some other commodities.

Among possible pitfalls that threaten Canada's position, the bank warned of a sudden rise in long-term interest rates and added financial stress in places such as Europe and China.

However, the bank said its overall assessment of Canada's financial stability remained roughly unchanged since its June review and the probability of an adverse shock had eased.

Following the release of the report, BMO Financial Group chief economist Doug Porter wrote in a research note that he expected the central bank to keep the key interest rate at one per cent until October.

"At least up to this point, they seem to be soft-pedalling concerns on the deep drop in oil prices ... while at the same time sounding a tad more concerned about the steady build in housing-related risks,'' Porter wrote in the note to clients.

"However, there is also little sense of urgency on their part about having to act on the still-robust housing market.''