Mortgage stress test gets Poloz off the hook on interest hike: Don Pittis

As of today, it's tougher to buy a house in Canada. And that could have effects beyond the mortgage market.

Although the new rules will likelymake first-time buyers and many in the real estate business unhappy,theywill take some of the pressure off Bank of Canada governor Stephen Poloz, who gives us an update on monetary policy the day after tomorrow.

• Rules could dampen housing market
• Ottawatargets foreign money

The main job of the central bank is to set interest rates at just the right level to keep the economy growing and inflation around two per cent.

Adjusting the thermostat

The theory is that lowering interest rates makes it easier forbusinesses to borrow and invest, creating new economic activity, using up the economy's spare capacity and creating jobs.

• Housing market correction or 'a whole lot of nothing'? Uncertainty as new mortgage rules come into effect

When the economy starts to get too hot, though,businesses begin competing for workers and other resources, driving inflation higher.

Central banks try to use interest rateslike a thermostat, lifting rates to cool the economy and lowering them to warm it up.

The trouble is that interest rates have different effects on different parts of the economy.

While business investment has remained stagnant, the low rates set by Poloz and the Bank of Canada have contributedto a frenzy of house buyingand soaring house prices, especially in Vancouver and Toronto. But using interest rates to put a lid on inflationof assets such as houses might kill off early signs of growth in other parts of the economy.

Blunt instrument

"If you're worried that housing prices aretoo high, the single rate that the Bank of Canada targets is too blunt an instrument," says University of British Columbiaeconomist Tom Davidoff.

But fortunately for the bank, governments have another mechanisms, which you may have heardmentioned elsewhere. They are called "macroprudential"tools, andInternational Monetary Fund boss Christine Lagardeadvocated themduring a September visit to Canada.

The idea is that instead of having central banks raise rates, governments createtargeted laws directed specifically at one overheated sector. In the case of the mortgage stress tests, that target is new entrants into the property market who may be in danger of borrowing more than they can afford.

Of course, many fearrules that kick in today and on Nov.30 limits on CMHCbacking for non-bank lendersand making sure Canadianswith insured mortgages can deal with a sudden increase in interest ratesmay be too broad.

"There is the issue, of course, that not every market is necessarily hot right now, so it's possible you'll cool off some markets without needing to," says Davidoff.

Poloz has repeatedlywarned about the theload of debt that Canadians are taking on.

Will Strange, a professor at the University of Toronto's RotmanSchool of Businesswith a specialty in real estate, says that of all the possible macroprudentialtoolsthe government could have used, today's new rules are focused squarely on debt.

Spillover effect

New evidence from the U.S. last week including the lowest jobless claims in 43 years and newly released minutes of the body that advises Fed chair Janet Yellen indicatethe U.S. central bank is about to start raising rates. U.S. rateincreases have a spillover effect into Canada since people with money to invest can send it across the border to get a better rate there.

While young househunters may be grumpy now because the law prevents them from spending as much, Strange says evidence from the U.S. shows the new rules may prevent afinancialhangover that would make them much grumpier oncethey could no longer afford their payments.

"The people who defaulted, when we follow them in their lives after the bust of 2007 in the U.S., they have trouble getting credit, they have troublebuying houses. There's all sorts of bad things that happened after," says Strange.

Tighter lending rules donot mean people cannot buy a home, just that they have to buy a less expensive home. And Strange says that could begin to push prices lower.

Tapping the brakes?

"The question is going to be, is this tapping the brakesor is this slamming them on?" he says.

People in the mortgage business say the new rules, by directing new borrowers away from cheap non-bank lenders, are effectively pushing interest rates up in the sector the government has seen as risky.

If that turns out to be true, it is exactly the effect the Bank of Canada wants, making rates higher on personal debt but leaving them unchanged for business debt.

A slowdown inpersonal debt and a moderate cooling in the overheated property market will mean Polozand his team haveeven more latitude to leave interest rates low, even as the U.S. begins to raise rates.

However, rising U.S.rates while Bank of Canada rates stay low will have a second spillover effect. Theywilltend to push the loonie down and inflation up asconsumer goodsget more expensive

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