Are Canadians heeding debt warning?

It may be too early to tell, but Canadians may be taking the Bank of Canada’s warnings on household debt to heart, according to a report from CIBC World Markets.

In November – the latest month for which data is available – household credit expanded at its slowest rate since 2001, growing by just 0.27% on an inflation-adjusted basis.

“After coming through the most leveraged period of consumer spending in recent history, Canadians are getting the message that they need to cut back on their debt levels,” says Benjamin Tal, deputy chief economist at CIBC, and author of the bank’s Household Credit Analysis Report.

He predicts household belt-tightening will continue throughout this year, as job creation slows from an average of 31,000 per month in 2010, to just 20,000 per month. This slowdown alone will shave 0.4 percentage points from growth in personal spending.

“But as important will be the change in the propensity to spend. With the U.S.-Canada saving rate gap at a 40-year high, and ongoing indications that monetary authorities wish to curtail the risky level of household debt, 2011 should see the beginning of an adjustment in the household balance-sheet.”

While Canadians may be reining in their consumptive spending, they have been slower at tackling their mortgage debt, which rose 7% on a year-over-year basis. But here too there are signs of improvement; the monthly growth rate appears to have slowed to between 0.4% and 0.5%.

“We estimate that the [Ministry of Finance’s] move to shorten the maximum mortgage amortization from 35 years to 30 years will cut the growth in mortgage originations by roughly two to three percentage points in 2011,” Tal says. “Overall we expect mortgages outstanding to rise by close to 5% in 2011 after an estimated 7.7% increase in 2010.”

The evidence suggests that Canadians are still able to manage their debt levels. Debt interest payments account for 7.2% of disposable income, making it the lowest debt service ratio since mid-2006.

Consumer bankruptcies are now trending lower with the number of bankruptcies falling nearly 25% on a year-over-year basis. The percentage of mortgages in arrears spiked in February 2010, at 0.43%, but Tal points out that this is well below the arrears rates of past recessions.

The downside of all this new-found thrift is that economic growth in recent years has relied on leveraged consumer spending. As Canadians repair their household balance sheets, that stimulus will vanish.

“The end result will be another year of only middling growth, but a new mix of economic activity as a vibrant business sector will gradually take over for an exhausted consumer and restrained government,” Tal says. “Look for the Bank of Canada to start raising rates as early as May of this year, but the overall speed and magnitude of future rate hikes will be limited by the growing effectiveness of monetary policy and a modest recovery.”