A report issued by the Bank of Canada today said that vulnerabilities resulting from rising household debt and sharply higher housing prices pose major risks to the Canadian financial system.

In the latest financial system review, the report issued by the central bank on Thursday said these two factors have increased downside risks to economic growth as rising rates aimed at tackling inflation increase the burden on households that have to divert consumption toward debt repayment.

For his part, a bank official said in his report: "In an environment of tighter financial conditions, rising global inflation, and increasing geopolitical tensions, vulnerabilities in the financial system have become more complex, and risks have become higher."

The report said that assessing vulnerabilities resulting from rising household debt has become more complex over the past two years, as household finances have generally improved even with increased debt levels.

Households have seen on average an increase in their net wealth of about $230,000 over the first two years of the pandemic, largely due to rising housing prices but also from rising stock markets and other gains.

However, the bank said that a growing proportion of households have squeezed themselves financially to buy a home, and these households in particular may not be able to benefit from the home’s value if housing prices undergo a correction.

In the same context, net worth also goes to the end of 2021 and does not reflect the recent decline in stock and real estate markets.

The bank said that strong growth in housing prices during the pandemic boosted the economy in the short term, but over the medium term, it may affect long-term economic growth.

The bank said that looking at the first quarter of 2024, trends have increased the probability of negative growth to 15 percent, up five percentage points compared to what it could have been if debt levels had not changed during the pandemic.

On the other hand, the increased chance of negative growth comes as central banks raise interest rates to confront inflation rates not seen in decades.

Potentially high costs come with housing prices up 24 percent in April compared to the previous year, and a 53 percent increase compared to April 2020.

The bank said part of the price gains may have been driven by expectations that prices would continue to rise simply because they did in the past, which could lead to a disconnect from fundamentals and expose prices to risk if a correction is made swiftly.

The bank points out that the share of investors has also grown as a share of homebuyers, rising from 19 percent to 22 percent of buyers, and they are leveraging the increased value of their current properties to buy more.

On the other hand, the resale housing market slowed significantly in March and April, but the bank says it is too early to know whether the slowdown is due to homebuyers making purchases earlier in the year to secure lower rates, or whether this is the beginning of a deeper and more permanent process.

The report said other vulnerabilities in the financial system also include cyber threats given the interconnected nature of the financial system, and fragile liquidity in fixed income markets.

It added that the Russian invasion of Ukraine has increased complexities and made economic challenges more difficult.

Editing: Dima Abu Khair