Anna Asi, M.A.

January 2011 CMHC Housing Market Report

OTTAWA, February 8, 2011 — The seasonally adjusted annual rate¹ of housing starts was 170,400 units in January, according to Canada Mortgage and Housing Corporation (CMHC). This is up from 169,000 units in December 2010. According to final figures, actual housing starts for 2010 totalled 189,930 units, with activity moderating towards demographic fundamentals by the final quarter of 2010.

“Housing starts moved slightly higher in January because of an increase in rural starts,” said Bob Dugan, Chief Economist at CMHC’s Market Analysis Centre. “Single-detached and multiple starts showed a moderate decline.”

The seasonally adjusted annual rate of urban starts decreased by 1.7 per cent to 146,900 units in January. Urban multiple starts moderated by 1.5 per cent in January to 82,900 units, while single urban starts moved lower by 2.0 per cent to 64,000 units.

January’s seasonally adjusted annual rate of urban starts decreased by 19.0 per cent in the Prairie Region, by 7.9 per cent in British Columbia, and by 1.0 per cent in Québec. Urban starts increased by 13.3 per cent in Atlantic Canada and by 10.3 per cent in Ontario.

Rural starts² were estimated at a seasonally adjusted annual rate of 23,500 units in January.

As Canada's national housing agency, CMHC draws on 65 years of experience to help Canadians access a variety of high quality, environmentally sustainable and affordable homes. CMHC also provides reliable, impartial and up-to-date housing market reports, analysis and knowledge to support and assist consumers and the housing industry in making informed decisions.

HIGHLIGHTS

• Over the past three rate deci­sions, the Bank of Canada has managed to take the overnight rate off the floor, and up to a level of 1.00%.
• However, we concur with the widely held belief that further hikes are off the table for now: a pause is by far the most likely outcome for the October 19th decision.
• There are three main reasons for our forecast.
• First, global conditions have become increasingly uncertain, and not a little gloomy.
• Second, Canadian economic data has consistently disap­pointed, and suggests future subpar growth.
• Third, intra-meeting Bank of Canada communications have been quite dovish.

After a sequence of nail-biting rate decisions extending back to the spring of this year, the market can finally coast into a Bank of Canada rate decision on auto-pilot. This one overwhelmingly argues for a pause, at least insofar as global and domestic economic conditions are concerned. The signals emanating from the Bank of Canada provide a welcome confirmation of this sentiment.

Market Developments

The bond market has suffered from a case of whiplash over the past several rate decisions. The pattern for the Bank of Canada has been to under-promise and over-deliver. That is to say, each statement has bemoaned the uncertainty in the world, and yet a rate hike has always followed like clockwork. This strategy was a clever one, as it pre­vented the market from tightening rates before the Bank of Canada was ready. Indirectly, it has prob­ably helped to keep the Canadian dollar in check throughout the summer.

However, for the first time in recent memory, the Bank of Canada’s communi­cation strategy was a little off kilter at the September meeting (or, more charitably, the market’s interpretation may have been awry). It failed to convey the expected degree of caution or concern. Thus, although the market had been prepared to take future rate hikes off the table, an October hike was briefly coaxed back into contention. At its peak, the market priced odds for this of over 50%.

However, these expectations were quickly snuffed out by Governor Carney’s speech a few days later. In it, he noted “non-negligible risk to the downside”, that “renewed weakness in the United States could have important implications for the Canadian outlook”, and that “the Bank will have to chart a careful course for Canadian monetary policy.” A subsequent speech on September 30th added to the caution. He noted that “the evidence is mixed [that growth in advanced economies will be self-sustaining]”, he criticized the quality of newly created Canadian jobs, and noted that, internationally, “very low policy rates could be in place for longer, and unconventional monetary policies could even be expanded in some major countries.” Tellingly, he also observed that “there are limits to [the] divergence” between Canadian and U.S. policy rates.

In turn, the market has worked to price out rate hikes, and currently sits at a cautious probability of under 20%. This is about right. A hike would be most unexpected, and a pause is entirely justifiable.

International Context

Canada can never be contemplated in complete geo­graphic isolation. As a small open economy, it is especially susceptible to global influences. These influences have been mostly undesirable of late. European fiscal problems have re-captured some of the market’s attention, with a newfound emphasis on an Ireland sorely in need of a fiscal pot of gold. U.S. economic data has been regularly disappointing and always weak, lending credence to double-dip soothsayers.

In turn, the U.S. Federal Reserve now muses openly about another round of quantitative easing. Japan has beat it to the punch, delivering its own brand of printed money and lower borrowing rates. The likes of Australia have paused when hikes were expected, and a host of other commod­ity players sit on the sidelines, such as New Zealand and Norway. Sweden provides a potent exception to the rule.

To get a full sense for the global desperation now regu­larly on display, some major nations have succumbed to interventionist FX policies that amount to feasting upon one another’s tails.

Canada is unlikely to adopt easier policy or to intervene in its currency market, but there are nonetheless conse­quences from the global actions. First, in the absence of a compelling need to raise rates, it would be unseemly to hike based upon lukewarm evidence whilst other countries contemplate cuts. Second, the Canadian dollar is likely to act as a shock absorber, transferring some economic weakness from abroad to Canada. Third, while the act of American quantitative easing itself might superficially ar­gue for tighter Canadian policy since it is already sending Canadian borrowing rates lower, this is powerfully offset by the thought that if the U.S. needs quantitative easing, the economic prospects for the U.S. (and by extension Canada) are also threatened.

Macro Developments

Within Canada’s confines, economic data have been quite weak, and far worse than expected. The TD Surprise Tracker shows an uninterrupted period of economic misses. The latest monthly GDP figure was negative, the latest Canadian employment report similarly revealed a net loss of jobs, and the most recent print of core CPI showed a flat monthly print.

This is not to say that Canada is in dire straits, because the country enjoyed quite a heady run through late 2009 and early 2010, and the amount of slack has been neatly trimmed. However, with GDP growth on track for no better than about 1-2% in the third quarter, and not much in excess of 2% thereafter, the urgency is gone. Housing is settling down and consumers are exhibiting more caution.

Our suite of Taylor Rules argue policy rates are about right given economic conditions. Granted, there is a huge variance among them, ranging from a recommended policy rate as high as 3% for the traditional Taylor Rule, to near zero for certain measures that incorporate smoothing and exchange rate effects. But the mean and median of the nineteen variations centre around the current policy rate of 1.00%, suggesting no great mismatch.

Under The Microscope

In the absence of a rate change, the Bank of Canada’s statement will be important, and should exude softness.

Current economic conditions should be described in more negative terms, with global growth sputtering and recent Canadian growth disappointing expectations.

Paired as it is with the quarterly Monetary Policy Re­port, the Bank’s forecast will get a rework. The statement should highlight some of the key points, including a likely downgrade to both the domestic and international forecast, as qualitatively signaled in the September statement. The magnitude of the downgrade is important: 2010 is mostly baked into the cake, and so the 2010 forecast will probably drop from 3.5% to about 3.0%, but this doesn’t convey much truly new information. 2011 is the more important year, and this is where the forecast becomes relevant. The Bank of Canada previously anticipated a 2.9% gain. By contrast, the IMF recently forecast 2.7%, and we at TD project just 2.0%. The forecast will likely be downgraded to somewhere in this range. If it arrives around 2.5%, the collective downgrades will result in an output gap that remains far from closed at the end of 2011, and instead the Bank may project a return to full capacity around mid-2012, or even later. Given the substantial shift, we highlight the risk that the inflation fore­cast might be pitched downwards, too, with a later return to a sustainable 2% level.

The Bank of Canada has tried to avoid commenting on the balance of risks in recent communiqués. We suspect this may again be the case. In the July MPR, the Bank assessed the risks as “roughly balanced”. It failed to comment on them in the September statement, but Governor Carney more recently spoke of “non-negligible risks on the downside” without bothering to comment on the status of upside risks. We are hesitant to predict a reprise of these comments, as the Bank has now had an opportunity to recentre its fore­casts, such that the risks should again be balanced, at least in theory.

As for the forward-looking statement, it probably re­mains in place: “any further reduction in monetary policy stimulus would need to be carefully considered in light of the unusual uncertainty surrounding the outlook.” Perhaps there is a chance the Bank opts to put more frills on the front end as per the preamble offered in Carney’s September 30th speech: “At this time of transition in the global recovery, with risks of a renewed U.S. slowdown, with constraints beginning to bind growth in emerging economies, and with domestic considerations that will slow consumption and housing activity in Canada, any further reduction in monetary policy stimulus would need to be carefully con­sidered.” Either way, no one will race to price in additional rate hikes at subsequent meetings with that sort of verbiage.

Medium Term Outlook

Our medium term outlook remains for a Bank of Canada on hold through the end of the year and into early 2011. We then imagine a slow but steady pace of tightening that results in a 2.00% overnight rate at the end of 2011, and a 3.00% rate at the end of 2012. Of course, the outlook remains colored by a kaleidoscopic set of factors that are subject to change, and the market takes a more cautious view than we.

This report is provided by TD Economics for customers of TD Bank Financial Group.

Sometimes it feels good to be surprised, but Tuesday’s anticipated announcement by the Bank of Canada that it is maintaining its target for the overnight rate at 1 percent was a relief.  The global economic recovery is entering a new phase, and the Bank of Canada is now expecting weaker-than-projected recovery across the board, especially in the United States.  Canada is not an exception in this shift in projections since July’s Monetary Policy Report, as the Bank continues to expect the economic recovery here will also be more gradual.

Corresponding to the overnight right maintaining at 1 percent, the Bank Rate is set at 1 ¼ percent and the deposit rate is set at ¾ percent.  Growth rates in Canada are expected to be 3.0 percent in 2010, 2.3 percent in 2011, and 2.6 percent in 2012.  Although a portion of this more subdued profile is a result of the more gradual global recovery, it also takes into account a more subdued expectation for Canadian household spending.  The projections around household spending come from the decline in housing activity, and as a result, the increased focus on household debt considerations.

Instead of focusing on household and government expenditures, the composition of demand in Canada is expected to shift towards business investment and net exports.

Inflation in Canada has remained slightly below the July projections of the Bank of Canada, but the expectation is that the economy will return to full capacity by the end of 2012 instead of the previously forecasted beginning of that year.

It was a combination of all of these factors that the decision was reached to maintain the target for the overnight rate at 1 percent.  This new announcement continues to keep considerable monetary stimulus in place to continue to achieve the 2 percent inflation target during a time when Canada is coping with a significant excess of supply.  Given the transition in the global recovery, the weaker U.S. outlook, constraints beginning to moderate growth in emerging-market economies, and Canadian considerations that are expected to slow spending and housing activity in Canada, the Bank would need to carefully consider any further reduction in monetary policy stimulus.

Although this announcement is driven by a weaker global economy, the management of the painful current global reality within the confines of the Canadian economy should create a sigh of relief for the real estate and mortgage industry, as there is not any new pressure being pushed onto the industry after a painful 2nd quarter in 2010.