Bank of Canada believes this time rate cut will bolster housing market, not fuel froth

Bank of Canada Governor Stephen Poloz suggested Thursday that lower interest rates would not send home prices skyrocketing, but could instead help bolster consumer confidence and the housing market amid the spread of the new coronavirus.

Poloz told reporters following a speech in Toronto that the recent “shock” could weigh on people’s minds, possibly prompting them to be more cautious and hold off on making big purchases, a risk the central bank sought to get ahead of.

“My expectation is that we’ll see consumer confidence declining … as this unfolds, and that our hope is that lower interest rates will in some way mitigate that decline,” Poloz said.

Poloz’s comments came the day after the central bank cut its key interest rate by 50 basis points, to 1.25 per cent, citing the “material negative shock” the virus has given the forecast for the global and Canadian economies.

The Bank of Canada had held off from cutting its rate earlier in the year, but a lot has happened since the January rate announcement, Poloz noted. This includes the economic disruptions caused by COVID-19, which had prompted the U.S. Federal Reserve to cut its key rate the day before the Bank of Canada did.

“The outbreak and its effects could be more persistent,” Poloz said Thursday in a speech.

“Consumer and business confidence could be set back for a longer period of time, causing economic growth to slow more persistently. This could include longer-term layoffs, for example. At this point, we simply do not know.”

There have been other developments in 2020 as well, such as rail blockades and teacher strikes in Ontario, Poloz noted. The central-bank’s governing council, he added, had agreed the current dangers to the economy are more than enough to offset continuing concern about financial vulnerabilities.

“Indeed, declining consumer confidence would naturally lead to reduced activity in the housing market,” Poloz said. “So in this context, lower interest rates will actually help to stabilize the housing market, rather than contribute to froth.”

The Bank of Canada’s rate cut is expected to give homebuyers more purchasing power and has already led to drops in variable mortgage rates at commercial banks. Poloz, though, said the central bank expects the so-called B-20 mortgage guideline, which includes a stress test for loans that are not insured against borrowers defaulting, “will continue to improve the quality of the stock of mortgage debt.”

Even so, changes planned by the federal government and a federal regulator to the insured and uninsured mortgage stress tests could stoke further housing activity. Those tweaks are expected to lower the “floor” on the minimum rates, making it easier for borrowers to qualify.

Poloz called it a “desirable change,” because it will make the stress tests more responsive to actual interest-rate movements. Those rates have been falling, but the federal government has also proposed having a two percentage point “buffer” for the new benchmark rate for the stress tests.

If debt increases because interest rates are lower, Poloz suggested it would at least be “higher-quality debt” contributing to the rise.

“So that’s good reassurance to the central bank, which is trying to take account of these competing trade-offs,” he added.