While home prices continue to rise nationally the affordability gap won’t be solved by wage rises.

The Conference Board of Canada says that average pay for non-unionized employees is projected to be 2.4% in 2018, slightly up from the 2.2% actual increases seen in 2017.

Those working in pharmaceuticals and chemical products are expected to lead the wage rises with 2.7% while those in the health sector will see just 1.6% more.

“While the Canadian economy is firing on all cylinders this year, growth projections for next year and beyond show a slowing down of the economy. As a result, business leaders continue to exercise caution, keeping a cap on organizational spending and, by extension, salary increases,” said Allison Cowan, Director, Total Rewards Research, The Conference Board of Canada.

Regionally, Manitoba, Ontario, and Quebec lead the pack in terms of projected increases, with wage gains ranging from 2.6% to 2.5%.  Meanwhile, the lowest average base pay increases are expected in Alberta and Saskatchewan, at 2.1%.

BOC Will Raise Rates Only Cautiously

The Bank of Canada held overnight interest rates at 1.0% following two consecutive rate hikes at the July and September meetings. It was widely expected that the Bank would take a breather this round. The central bank also released its quarterly Monetary Policy Report (MPR) today, in which it forecast that growth would be 3.1% this year, 2.1% in 2018 and 1.5% in 2019. The rapid pace of economic growth over the past four quarters surprised the Bank on the high side. Going forward, the Bank forecasts GDP to moderate to a more sustainable pace.

Exports and business investment are expected to contribute to growth over the forecast horizon. In contrast, “housing and consumption are forecast to slow in light of policy changes affecting housing markets and higher interest rates.” The Bank went on to say that “because of high debt levels, household spending is likely more sensitive to interest rates than in the past.” I would go one step further and suggest that higher sensitivity to interest rates is all the more so because of the OSFI stress testing of borrowers at 200 basis points above current contract mortgage rates.

The central bank continues to expect global growth to average roughly 3.5% over the 2017- 2019 period, noting that uncertainty remains high regarding geopolitical developments and fiscal and trade policies. Notably, the renegotiation of NAFTA will have a meaningful impact on the economies of North America, but given the uncertainty, the Bank economists have left this factor out of the base case projection.

Measures of core inflation have edged up as expected, but the Bank now forecasts that inflation will rise to 2% in the second half of 2018, which is a bit later than anticipated in the July MPR reflecting the recent strength in the Canadian dollar.

Business investment contributes to increases in capacity and productivity; hence the Bank of Canada now assumes that annual growth of potential output is 1.5% over 2018-19, which is slightly above the assumption since April 2017. How fast the economy can grow without triggering inflation is a big issue these days. The central bank will publish a full reassessment of this critical point in April 2018. The higher the level of potential growth, the lower the estimated level of the “neutral” nominal policy rate–the level of the overnight rate that is consistent with the Bank’s target of 2% inflation. The Governing Council of the Bank of Canada now estimates the neutral rate to be between 2.5% and 3.5%. The Bank’s economic projection is based on the midpoint of this range– 3.0%. In other words, the Governing Council of the Bank of Canada estimates that it will ultimately raise the policy rate from the current level of 1.0% by 200 basis points to 3.0% once the economy is at full employment. That is a substantial proportional jump in rates, which would undoubtedly slow interest-sensitive spending, and nothing is more interest-sensitive than housing. Which makes you wonder why the financial institutions’ regulator (OSFI) has been so intent on further tightening mortgage credit conditions.

The tone of today’s policy statement was decidedly more dovish–cautious about future rate hikes–than in July and September. Why is that? Firstly, the Bank came under a good deal of criticism for hiking rates more rapidly than expected, reversing the two rate cuts implemented (unexpectedly) in 2016. Secondly, the Bank sees significant risks to the outlook. These risks are delineated in the MPR as follows:
• A shift toward greater protectionist trade policies in the U.S. that weaken Canadian exports
• A more substantial impact of structural factors (Internet, digitization, robots) and prolonged excess supply on inflation (higher potential growth)
• Stronger real GDP growth in the U.S. (owing to prospective deregulation and tax cuts)
• Stronger consumption and rising household debt in Canada
• A pronounced drop in house prices in overheated markets

The Bank of Canada sees the risks to the inflation outlook as balanced–in other words, it is just as likely for inflation to move above forecasted levels as below them. Hence, the Bank will be cautious in raising interest rates in the future and their actions will be data dependent. In their words, “while less monetary policy stimulus will likely be required over time, Governing Council will be cautious in making future adjustments to the policy rate. In particular, the Bank will be guided by incoming data to assess the sensitivity of the economy to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation. “

The Canadian economy has grown at a stronger-than-expected annual rate of 3.7% in the past year, taking the jobless rate down to its lowest level in nearly a decade. With Canada’s economy the strongest in the Group of Seven countries, Ottawa now projects much smaller deficits than it did in March. The Liberal government cut its deficit projection for the fiscal year that ends March 31 to just under $20.0 billion, down from $28.5 billion in the March budget. It now expects a cumulative deficit over the coming five fiscal years of $86.5 billion, compared with $120 billion previously.

Finance Minister Bill Morneau announced new spending today totalling $7.7 billion over six years, bringing the total new spending since the March budget to $19.1 billion over six years. This additional stimulus comes as the economy is running far faster than its long-run potential noninflationary pace, rapidly approaching full capacity. The Bank of Canada has already raised interest rates twice since the summer and meets again on Wednesday. While we do not expect the Bank to hike rates tomorrow, additional fiscal stimulus runs the risk of ever tighter monetary policy–meaning higher interest rates than otherwise would be the case down the road. Higher interest rates slow interest-sensitive spending and nothing is as sensitive to rates as home purchases. With all the government’s concern about the record level of household debt, tighter monetary policy might well be welcome.

The government has already taken repeated actions to slow the housing market. Most recently, the federal financial institutions’ regulator, OSFI, has tightened the stress testing for non-insured mortgage borrowers effective in January.

Deficit spending, particularly the enhanced child benefit system, has undeniably been fueling consumption. The government announced today it would index its marquee Canada Child Benefit to inflation beginning in July 2018, two years earlier than scheduled. It also expanded the Working Income Tax Benefit, which supplements the earnings of low-income workers, starting in 2019. It also reduced the small business tax rate to 10%, announced last week, and it snuck in changes to the tax system that “ensure low corporate tax rates go towards supporting businesses, not to the top 1% of income earners”. In that regard, Ottawa is proceeding with a new tax on investment income held in private corporations and will detail the measure in its 2018 budget.

Trudeau’s team has been backtracking on a trio of tax proposals unveiled by Morneau in July and offered new details in its update on Tuesday. It will proceed to restrict so-called income sprinkling — paying family members who don’t work for a firm — with new legislation due later this year. The Liberals will also tax investment income held in private corporations when it exceeds $50,000 annually, releasing rules for that in its 2018 budget. It has abandoned a third proposal, which changed capital gains rules.

Despite the improved economic outlook, there is no forecast to return to budgetary balance, although the debt-to-GDP ratio does fall more rapidly than in the 2017 budget.

OSFI has published its update for the tightening of mortgage lending regulations known as Guideline B-20 and set the date that it will apply.

The revised Residential Mortgage Underwriting Practices and Procedures will take effect from January 1, 2018 and include several key changes that the regulator says is part of its expectation that federally-regulated mortgage lenders remain vigilant in their underwriting practices.

• Stress test – the minimum qualifying rate for uninsured mortgages to be the greater of the five-year benchmark rate published by the Bank of Canada or the contractual mortgage rate +2%.
• Enhanced LTV measurement – federally regulated financial institutions must establish and adhere to appropriate LTV ratio limits that are reflective of risk and are updated as housing markets and the economic environment evolve.
• Restriction of certain lending arrangements –  federally regulated financial institutions prohibited from arranging with another lender a mortgage, or a combination of a mortgage and other lending products, in any form that circumvents the institution’s maximum LTV ratio or other limits in its residential mortgage underwriting policy, or any requirements established by law.

“These revisions to Guideline B-20 reinforce a strong and prudent regulatory regime for residential mortgage underwriting in Canada,” said Superintendent Jeremy Rudin.

The full guideline update is available from the OSFI website.

Canada’s banking regulator has published the final changes to its guidelines for residential mortgage underwriting, including a financial stress test for buyers who don’t need mortgage insurance.

The Office of the Superintendent of Financial Institutions said Tuesday the changes will come into force by Jan. 1, 2018.

Even homebuyers who don’t require mortgage insurance because they have a down payment of 20 per cent or more will have to prove they can continue to make payments if interest rates rise.

Other changes include restrictions on co-lending, or bundled mortgages, aimed at ensuring financial institutions do not circumvent rules that limit how much they can lend.

The final guidelines are generally similar to what OSFI had proposed in July, when the regulator put out a draft for public consultation.

The proposed changes, however, have been criticized for including potentially increasing costs and limiting access to mortgages for some home buyers.

“These revisions to Guideline B-20 reinforce a strong and prudent regulatory regime for residential mortgage underwriting in Canada,” said Superintendent Jeremy Rudin in a statement on Tuesday.

Another organisation has added its voice to those opposing OSFI proposals to introduce tougher lending restrictions for uninsured mortgages and warns it could harm competition in the mortgage industry.

The Fraser Institute says that requiring a stress test with a margin of 2 percentage points above the agreed rate for those homebuyers with at least a 20% downpayment, is unnecessary and could negatively affect buyers across Canada.

In a study called Uninsured Mortgage Regulation: From Corporate Governance to Prescription, author Neil Mohindra says there are several potentially negative effects from the proposed rule-tightening:

Access to mortgages may become more limited, especially for buyers in high-price markets;

Buyers may be forced to abandon preferred homes for less-desirable options;

Increased use of unregulated lenders with higher interest rates;

Buyers may opt for shorter term variable rate loans.

The report also suggests that the mortgage industry could become less competitive from the OSFI rule as those lenders that are niche players in the residential market may find their business is impaired.

This, the report concludes, runs counter to the federal government’s objective of promoting more competition from smaller lenders.

“OSFI’s emphasis on corporate governance worked well during the financial crisis. Shifting towards more prescriptive rules is an ominous sign,” Mohindra said.