The surge in net wealth that many Canadians enjoyed during the pandemic as the value of their homes skyrocketed and high-flying stocks bolstered their investment portfolios is reversing course, RBC Economics says.
The downturn in the real estate and financial markets means Canadians could see a total of $1.6 trillion in net wealth erased in the coming quarters, the bank said in a report released on Wednesday. While that won't wipe out all of the estimated wealth gains made during the pandemic, it's already having a chilling effect on consumer spending.
From peak to trough, RBC estimates it would represent a 41 per cent decline in collective net worth.
"Still, for the most part, the sharp decline in net wealth is starting to hit home," the report said.
"Households can finance spending either out of current income or by drawing from their net wealth. As a result, when their net worth declines, so does their confidence about spending."
Economists commonly refer to this phenomenon as the wealth effect, meaning when an individual simply perceives themselves to be richer because of higher asset values, they're more inclined to spend money. The opposite is true when individuals feel less wealthy.
During the pandemic, historically-low interest rates helped fuel a flurry in housing market activity that lifted home prices. Stock markets also hit record highs as investors expected lower rates to help boost profitability. RBC estimates net worth in Canada soared $3.9 trillion from the last quarter of 2019 to the first quarter of this year.
However, interest rates have risen rapidly over the course of 2022, leading to a decline in the real estate sector and souring investor sentiment in financial markets.
RBC says Canadian net wealth fell by $900 billion in the second quarter alone, the fastest pace on record.
With Canadians reluctant to open their wallets, it's set to take a toll on the economy.
"Discretionary or non-essential spending on things like home furnishings and renovations drove the pandemic spending surge. But as interest rates rise and price pressures persist, Canadians will increasingly prioritize necessities like groceries and gas—and debt," the report said.
"We estimate households will soon have to allocate 15% of their take-home pay just for debt servicing, with half of this attributed to mortgage costs."
RBC recently moved up its call for a recession in Canada. It now sees a moderate contraction happening in the first and second quarters of next year, a quarter earlier than its previous forecast, as rising borrowing rates squeeze household budgets.
Michelle Zadikian is a senior reporter at Yahoo Finance Canada. Follow her on Twitter @m_zadikian.