High levels of household debt and sections of the housing market that refuse to cool remain the biggest domestic threat to Canada's economy, the country's central bank says.
"These household imbalances could themselves be a trigger for financial system stress or they could amplify adverse economic shocks originating elsewhere," the Bank of Canada said on Thursday in its Financial System Review, which is essentially a twice-a-year check up on the stability of the system.
The Bank says Canadians are vulnerable to two major and interlinked shows: a significant decline in housing prices and a sharp deterioration in the job market.
The bank notes sales of existing homes have declined and the growth in house prices has slowed. But with the ongoing strong rates of construction, particularly of multiple-unit dwellings in some regions, there are increased worries about "future stock imbalances."
"In this context, there are two dimensions to this risk: on the one hand, a rebound in housing-market momentum may cause a further buildup of imbalances, while on the other hand, the current moderation in the housing market may turn into a more severe correction," it said.
In July, the federal government tightened mortgage lending rules -- the fourth such move since 2008 -- as household debt levels skyrocketed against a backdrop of a frothy real estate market that had been fueled, in part, by ultra-low interest rates.
What does it all mean?
Essentially an oversupply in the condo market could shift the supply-demand dynamic, sparking a sudden correction in prices, the bank said.
"Price corrections in particular segments of the housing market may put downward pressure on house prices more generally. This would likely lead to a decline in housing activity, adversely affecting household incomes and employment, as well as confidence and household net worth, which would in turn reduce household spending," the bank said.
That could then create a domino effect that would hit the broader economy.
David Tulk, chief Canada macro strategist at TD Securities, said the impact of the tighter mortgage regulations that took effect in July has slowed activity in the housing market but it is too soon to tell if the effect will prove to be temporary.
"I think it's a state of the world where we need to be quite vigilant watching how the housing market unfolds," said Tulk.