Canada’s household debt load took a notable step back from near-record levels in the first quarter of the year, as the trifecta of tougher mortgage rules, rising interest rates and accelerating incomes delivered a dose of relief that policy makers have long been looking for.

Statistics Canada reported on Thursday that the ratio of household credit-market debt to disposable income – the most closely watched measure of Canadians’ debt burden – fell for the second straight quarter to a two-year low of 168 per cent, from 169.7 per cent in the fourth quarter. It was the biggest quarter-to-quarter decline in Statscan’s 28-year record of the measure and comes after Ottawa’s new mortgage-borrowing restrictions went into effect on Jan. 1.

The impact of the new rules – as well as rising mortgage rates as a result of three quarter-percentage-point rate increases by the Bank of Canada since last July, the most recent coming in mid-January – was evident in mortgage borrowing, which declined 13 per cent from the fourth quarter to $13.7-billion, the lowest level in nearly four years. Statscan said the slowdown reflected a 17-per-cent drop in residential resales in the quarter, as the new mortgage rules and higher interest rates took hold. The rise in home prices has also slowed dramatically: The Teranet-National Bank national house price index, released on Wednesday, showed year-over-year growth of a tame 4.5 per cent in May, the slowest pace since the end of 2013.

“Macroprudential measures and the cooling of Canada’s housing market are having the desired effect on household’s balance sheets,” said Robert Hogue, a senior economist at Royal Bank of Canada, in a research report.

Meanwhile, improving growth in Canadians’ paycheques is delivering a boost to the other side of the debt-to-income equation. Statscan said that while overall household debts still crept up 0.3 per cent from the fourth quarter, disposable income rose a brisk 1.3 per cent.

“We may finally be at a turning point,” said Bank of Montreal economic analyst Priscilla Thiagamoorthy in a research note.

“The [Bank of Canada] will look favourably on that shift, even as elevated household debt remains a vulnerability,” she said.

Canada’s high household debt loads have been a concern at the Bank of Canada for years, as it has worried that a sudden economic shock could put a lot of Canadian families in trouble, posing a danger both to the economy and to the country’s financial stability. The central bank’s Financial System Review, a major report released this week, listed household debts as the No. 1 vulnerability to the financial system.

In that report, the Bank of Canada noted that the situation had improved, citing the slowing debt growth and “improvements in credit quality” stemming from the rise in interest rates and the tightening of mortgage regulations. “But even as conditions slowly improve, the sheer size of the outstanding debt means that the vulnerability will likely persist at an elevated level for some time,” it cautioned.

“Developments in the last two quarters are unlikely to change the conversation about household indebtedness in Canada entirely, though they are enough to alter its tone,” Royal Bank’s Mr. Hogue said. “With growth in both mortgage and non-mortgage debt slowing, debt metrics should continue to improve in the near term.”

However, with the Bank of Canada poised to increase interest rates further this year in light of an economy running at close to full capacity and inflationary pressures rising, Canadians who are carrying high debts face growing pressures on the cost of carrying those debt loads.

Canadians’ debt-service ratio – which measures combined principal and interest payment obligations as a proportion of disposable income – held steady at 13.9 per cent in the first quarter, as incomes and interest rates both rose. But Statscan noted that in mortgages – which account for about two-thirds of household debt – total interest payments rose 3.7 per cent in the quarter, even as principle payments dipped 0.2 per cent.

“In a rising interest-rate environment, much of the focus will also be on how Canadian households will manage their debt service costs,” Mr. Hogue said. “We expect that [the debt-service ratio] will come under upward pressure in the period ahead. In our view, this will be a key factor restraining household spending growth this year. It will also be an element keeping the Bank of Canada cautious about raising rates.”

Meanwhile, Statscan also reported that Canada’s total household net worth slipped 0.2 per cent in the quarter, the first decrease since the third quarter of 2015. It blamed the dip mainly on declines in stock markets.

“That shouldn’t be a big worry at this stage, considering the degree to which households’ assets (both financial and non-financial) have increased over the past several years,” Mr. Hogue said.

The Globe and Mail, June 15, 2018