Can households sustain Canada’s economic recovery?

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By BDC

MONTREAL, Canada – Economic growth relies heavily on household spending. While household wealth has increased during the pandemic, there remains much uncertainty about how vulnerable consumers are to financial setbacks.

With inflation rising, the real estate market in a frenzy and interest rate hikes looming, how well positioned are Canadian households to support the economy in 2022?

Household savings could be a double-edged sword

If there was one positive economic outcome from the pandemic, it was probably the increase in household savings. In 2020, repeated lockdowns limited the ability of households to spend while government relief programs contributed to increased personal income.

The result is close to $300 billion in excess savings accumulated by Canadians since the beginning of the pandemic. This represents more than 10 percent of GDP, which is huge.

However, all this saving is not an unmitigated positive for the economy. The Bank of Canada has identified it as a potential source of higher inflation. With the supply of goods and services already under pressure from high consumer demand, even more spending could cause the economy to overheat.

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Real Estate: A source of wealth, debt and risk

It may seem odd, but despite sky-high savings levels, overall debt still increased during the pandemic because of higher mortgage debt.

Demand for homes has been stimulated by low interest rates and telecommuting during the pandemic. On the supply side, inventory in the resale market has continued to decline from already low levels. This has generated surging home prices and mortgage debt.

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Anticipation of a strong economic recovery in early 2021 has pushed fixed mortgage rates ahead of variable rates, leading to more than half of mortgages originated in the third quarter of 2021 being variable rate. This makes households more vulnerable to changes in the Bank of Canada’s rate than in the past, a situation that is exacerbated by a larger share of mortgages carrying high loan-to-value ratios due to the recent price spike.

Don’t underestimate the wealth effect

Presumably, Canadian households have taken advantage of their accumulated savings to pay down some debt and invest in the housing market. A good portion of the pot will also have been invested in the stock market.

Thanks to the good performance of the financial markets and higher home prices in 2021, household wealth has increased considerably—at least on paper. This wealth is not very liquid and can’t be readily spent to support economic activity directly. It would, therefore, be surprising if it fed a rapid increase in inflation.

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On the other hand, the wealth effect suggests that consumer spending will continue to increase in the coming months, which is good news for the economy.

The impact for your business

  • The high level of household savings accumulated during the pandemic will continue to support growth, even though higher inflation will reduce the purchasing power of Canadians.
  • The wealth effect generated by the good performance of the real estate and stock markets should also contribute to maintaining solid demand.
  • Consumers appear cautious despite the reopening of service industries and borders. Demand should grow more gradually in coming months, in the context of rising interest rates.

Source: BDC

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