Soaring house prices in Vancouver and Toronto unsustainable, Bank of Canada says

The Bank of Canada says surging prices in real estate markets like Vancouver and Toronto are not sustainable at their current pace.

In its latest assessment of Canada’s financial health, the central bank took aim at the housing sector, saying vulnerabilities due to the continued rise of household debt and greater imbalances in regional housing markets are higher than they were six months ago.

The severity of the risks associated with a sharp correction in real estate prices in Vancouver and Toronto as well as from household financial stress has risen, said the bank’s semi−annual financial system review released Thursday.

"In this risk scenario, a severe recession in Canada generates a sharp increase in unemployment across the country that places many highly indebted households under financial stress and causes a broad−based correction in house prices," the bank said.

"This chain of events would strain the financial system and the real economy. Such a scenario might unfold if a large negative demand shock hit the Canadian economy, but the probability of this risk occurring remains low."

The bank warned that soaring prices in Vancouver and Toronto, as well as some of their adjacent areas, may also be supported by "self−reinforcing price expectations." It added that it’s unlikely economic fundamentals will justify continued strong price increases.

"This suggests that prospective homebuyers and their lenders should not extrapolate recent real estate performance into the future when contemplating a transaction," Bank of Canada governor Stephen Poloz said in a statement that accompanied the review.

The caution came as the federal government faces pressure from researchers, bankers and other housing sector observers to address expanding household indebtedness and rising house prices, particularly in Toronto and Vancouver.

On Wednesday, Finance Minister Bill Morneau said Ottawa was conducting an in−depth examination of the country’s real estate markets to determine what measures might be necessary to ensure Canadians can still afford to buy homes.

Morneau did not specify what sort of changes the government was considering or how soon it may introduce them.

Over the winter, he increased the minimum down payment for homes over $500,000 to 10 per cent from five per cent, a measure aimed specifically at cooling off the Toronto and Vancouver markets.

Ottawa is also examining whether there is any evidence to support the notion held by some that foreign buyers are driving up home prices, Morneau added.

The Bank of Canada’s report said foreign demand has contributed to price growth in Vancouver and Toronto, which boosts overall household indebtedness. But it added that it’s currently difficult to measure the impact of foreign investment.

The document said year−over−year house price growth in the greater Vancouver area hit 30 per cent last month, up from 15 per cent in December. In Toronto, prices increased by 15 per cent, compared to 10 per cent six months ago.

The report, which examines vulnerabilities and risks to the financial system, also highlighted other persistent concerns.

It pointed to the continued presence of fragile fixed−income market liquidity as a key vulnerability in the overall financial system, while it repeats the risks of a sharp increase in long−term interest rates, stress from emerging markets like China and prolonged weakness in commodity prices.

"The overall level of risk to Canada’s financial system is largely unchanged from six months ago," the bank said.

"While household vulnerabilities have moved higher, the ongoing economic recovery in Canada means that the overall risk remains the same. The Canadian financial system is resilient and functioning effectively."