Canadians, buckle your seat belt and prepare for a little turbulence in the coming months. Oxford Economics warned investors to prepare for a hard landing for Canada’s economy. The research firm attributes the coming shock to high debt loads, elevated inflation, and rising rates. The resulting shock is forecast to lower home prices around 30% from the peak.
Canadians Should Prepare For A Hard Landing
A hard landing is a recession that happens after a rate adjustment, when trying to calm inflation. This is in contrast to a soft landing, where rates rise but the economy only slows — no recession. Tony Stillo, a director at Oxford Econ, expects a moderate recession to kick off in Q4 2022. He attributes rate hikes, high inflation, and weak global demand for the forecast.
Currently they see a moderate recession within the next six-months. The firm’s models show a contraction of 1.8% peak-to-trough, from Q4 2022 to Q2 2023. A recession of this size would be considered moderate, so we’re past the point of a soft landing or mild rough patch.
Canada’s Supersized Debt To Weigh On The Recovery
Canadian households are too highly indebted to mount a flexible response. Due to supersized debt loads, small increases in interest will add up to a big diversion of income. The firm is forecasting 8.2% of disposable income will be used to carry mortgage payments in Q2 2023, up from 6.5% this year. It’s higher than the 2018-2019 debt cycle, consuming the biggest share of income since 2009.
“Canada’s historically high household debt and housing prices make the economy much more sensitive to interest rates,” said Stillo. “Sharply higher interest rates will cause debt service costs to jump and the significant housing correction already underway to deepen. Additionally, reduced real income due to stubbornly elevated inflation will further squeeze households and prompt cuts to discretionary spending and a period of deleveraging.”
The firm’s calculations show a typical mortgage will rise by an average of $162 (+11.3%) to $1,590/month in Q2 2023. It’s a sharp increase, but the total is lower than the average rent for a 1-bedroom due to inflation. It’s going to be hard for homeowners to get sympathy.
Canadian Real Estate Prices Fell Over 30% From Last Year
Canadian real estate prices are forecast for a steep correction in housing. However, it won’t return home prices back to the pre-2020 prices. “Our forecast for a 30% housing correction returns the benchmark home price to its late-2020 level since it only partially erases the 50% pandemic surge,” Stillo explains.
In this scenario, the benchmark home price would remain 7% higher than pre-COVID levels. “… potential losses in housing wealth should be contained to recent homebuyers and largely unrealized for longer-term homeowners,” he said.
Depressed home values don’t necessarily lead to defaults and realized losses. Most homeowners tend to pay their mortgage through a downturn, since they still need a place to live. Liquidity is a bigger concern for investors, since the buyer pool will be much smaller. A 30% price drop with a recession isn’t likely to bounce back to all-time highs very fast.