Posted by: Daryl & Wendy Ashby | May 12, 2010

Zip Up Your Wallet

Canadians’ eyes are bigger than their wallets, according to a study that suggests that consumer confidence is headed for a fall.

 The CIBC study, released Thursday, measured capability — as opposed to confidence — and found that the post-recession spending has been a case of Canadian’s reach exceeding their grasp of their true financial situation.

 “Despite Canadian consumers’ high spirits, their recent consumption pattern has not been supported by an equivalent increase in income,” said Benjamin Tal, senior economist at CIBC World Markets. “In fact, growth in real disposable income has been trending downward over the past year and to a certain extent debt is replacing income as a major driver of consumer purchases.”

 Household debt — mostly mortgage debt — is growing three times faster than income, he said.

 The Conference Board of Canada reported consumer confidence reached a low at the end of 2008 and has since rebounded by 60 per cent, back to its long-term average, Tal notes.

 “But while improved sentiment can provide a short-term lift to household spending, a sustainable boost in activity must eventually be backed up by improving consumer fundamentals such as income growth, falling unemployment and reduced debt burdens,” he said.

 Confidence surveys rely on Canadians to “self-report” their mood, Tal said, while the CIBC’s Consumer Capability index is an objective measure of factors that determine not Canadians’ willingness to spend, but their ability: debt-to-income and debt-to-asset ratios; real income growth; the long-term unemployment rate; house price to income ratio; personal savings rate; and personal bankruptcy rate.

 “Combining all of the above information into one index reveals that Canadian consumer fundamentals are weaker than they have been in almost 15 years,” Tal writes. Household debt is rising twice as fast as assets, personal income growth is “softening” and the gap between income and house prices is at a 20-year-high, which Tal says means real estate markets will stagnate or fall over the coming years as mortgage rates rise and increased housing starts bring prices down.

 “Those minuses are moderated by the recent increase in the saving rate, and a low long-term unemployment rate, but overall the balance is still weighted to the downside,” he said.

 That means that consumer spending will stall over the next 12 months, he said.

 The Bank of Canada will need to take consumers’ vulnerability into account when it starts hiking its key interest rate from its current historic low of 0.25 per cent, he added, because “even a moderate monetary squeeze will be sufficient to drive a material deceleration in consumer spending.”

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