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Posthaste: Canadians just saw the biggest drop in wealth on record — and the pain's not over Back to video

Good Morning!

Canadians built up a lot of wealth during the pandemic — now as interest rates rise and housing prices fall, they are watching it unravel at the fastest pace in decades.

Wealth soared during COVID, as lockdowns curbed spending, government aid flowed and most significantly, housing prices spiked into the stratosphere.

Canadians’ net worth rose by $3.8 trillion between the end of 2019 and the first quarter of 2022, helped along by a 52 per cent leap in home prices, say RBC economists Nathan Janzen and Carrie Freestone in a report this week.

Now that is reversing fast. Net wealth cratered in the second quarter, shedding $900 billion in the largest drop on record as the housing market deflates under rising interest rates and stuttering financial markets, they said.

And when Canadians’ wallets suffer, so does the economy.

Households either finance spending out of current income or by drawing on their net wealth, the economists say — home equity loans, for example. If that wealth declines so does their confidence to spend.

For years economists have tried to measure this “wealth effect.” One early estimate by the Bank of Canada suggested that a $1 decline in net wealth led to a 5.6 per cent decline in household consumption.

RBC’s estimate is more conservative — a 1.3 per cent decline in consumption for every dollar lost in home equity.

Either way changes in net wealth have power over consumer demand and thus, the economy, especially when they are this massive.

At the same time as their wealth is declining, Canadians are being squeezed by decades-high inflation and rapidly rising interest rates. RBC expects that under these pressures, Canadians will spend more money on necessities like food, gas and shelter, and less on discretionary items, like new patio furniture.

The economists estimate that households will soon have to allocate 15 per cent of their income to debt servicing alone.

And the pain isn’t over, they say. “We expect losses to net wealth to total $1.6 trillion in quarters ahead, leaving Canadians feeling less wealthy and less confident about spending.”

That’s bad news for the economy.

RBC estimates the “dramatic” drop in net wealth, combined with inflation and rising rates, will cut household spending by $15 billion in 2023 and work as one of the forces that will drive Canada into recession early next year.

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A hawkish 50 is what some economists are calling the Bank of Canada’s move yesterday. On the one hand the central bank surprised markets by raising the interest rate less than expected; on the other it sent strong signals that there were more rate hikes to come.

“We are getting closer to the end of this tightening phase but we’re not there yet,” Governor Tiff Macklem said during a news conference.

So what’s next?

RBC economist Josh Nye, who nailed this rate prediction, said 50 basis points is still considered an outsized rate increase, and to justify it the Bank stressed that inflation remains a problem. At the same time, it slashed its outlook, projecting that GDP growth will “essentially stall.”

“While the BoC isn’t using the r-word, it acknowledged “a couple of quarters with growth slightly below zero is just as likely as a couple of quarters with small positive growth.” That might be as close as the central bank will come to calling a recession until we’re actually in one,” Nye wrote in a note.

“Today’s dovish pivot supports our view that the BoC will continue to taper its tightening cycle into year end with a 25 bp increase in December leaving the terminal rate at 4 per cent,” Nye wrote in a note.

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Today’s Posthaste was written by Pamela Heaven, @pamheaven, with additional reporting from The Canadian Press, Thomson Reuters and Bloomberg.

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