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A softer Canadian housing market, the end of federal stimulus packages and guarded spending by U.S. consumers will be a drag on Canada’s economy, according to a report by Avery Shenfeld, Managing Director and Chief Economist with the wholesale banking arm of CIBC.
The CIBC projects the real Canadian gross domestic product, an inflation-adjusted measure of the economy, will grow by 1.9 per cent in 2011, compared with the 3.2 per cent pace assumed in the 2010 federal budget last March.
Ontario will take the brunt of the expected blow — falling an estimated 1.6 per cent below the forecast for next year — because about 80 per cent of its exports are shipped to the United States.
Meanwhile, other provinces heavily weighted in export industries will suffer notable declines. Quebec is expected to see provincial GDP fall 1.1 per cent, while Manitoba is projected to fall one per cent short of forecasts, CIBC said.
Resource-heavy provinces like B.C., Alberta, Saskatchewan and Newfoundland and Labrador will lead growth but are expected to also face challenges meeting their budget forecasts.
Western Canada could face a tougher challenge in its housing market, where prices have overshot fair market value by the largest margin. That’s expected to have a slowdown effect on residential construction, the report said.
Shenfeld said the federal government shouldn’t allow a softening economy to derail plans to return to a balanced budget, and instead the Bank of Canada could back off from plans for higher interest rates, to adjust for a more challenging economic environment.
“We have started the process of raising interest rates, presumably to prevent growth from being so brisk that inflation breaks out. If policy needs to adjust to a more challenging climate abroad, it should be done by backing away from plans for tightening through even higher interest rates,” elaborated Shenfeld.
“Only if the Bank of Canada were forced to take rates back to zero would it be appropriate to postpone a much-needed, if gradual, path back to fiscal rectitude.”
Fed gives Carney some reasons to pause
Bank of Canada Governor Mark Carney said Friday that if the U.S. Federal Reserve were to embark on another round of asset purchases, a strategy known as quantitative easing because policy makers seek to reduce interest rates by increasing the money supply, it would factor into whether he would continue lifting Canada’s benchmark interest rate, which now sits at 1 per cent.
“There are limits to the divergence that there can be between Canada and the United States,” Mr. Carney said in an interview with the CNBC business television network.
The Fed has not yet decided to return to quantitative easing, but its concession this week that it’s worried about falling short of its inflation and employment targets without fresh stimulus clouds the outlook for countries in better shape, especially Canada.
Mr. Carney’s comment was notable because Canadian central bankers tend to play down any link between the Fed’s decisions and their own. The idea is to discourage the notion that the Bank of Canada is a mere copy cat of its American cousin when it comes to setting interest rates. And for the most part that is true: Mr. Carney has increased Canada’s benchmark overnight rate three times since June, while the Fed’s key borrowing rate remains near zero and U.S. policy makers repeated this week that they intend to leave it there for a considerable amount of time yet.
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A long-term mortgage may be just the insurance some people need
Most of the focus of the mortgage industry in Canada is on five-year fixed-rate mortgages, still the most popular fixed-rate product for consumers. The federal government cemented that popularity with new rules in April that favoured Canadians locking in their rate for five years by making qualifying for the product easier.
But there’s a significant number of Canadians who have become even more conservative than the federal government anticipated and are locking in longer-term rates. The trend may have something to do with the rates themselves, which have dropped to 4.95% on a 10-year mortgage.
Although since 1975 borrowers who opted to go variable were the financial winners 82 per cent of the time, fixed rates were advantageous through the late 1970s and briefly in the late 1980s, and in both cases ahead of a period of rising interest rates, as it is the case now.
Statistics from the Canadian Association of Accredited Mortgage Professionals show how 12% of the Canadian mortgage market is in a term longer than five years. Setting aside the five-year term, the most popular mortgages in Canada are seven and 10 years. CAAMP estimates about two-thirds of that 12% figure is in a seven-year mortgage with the other third in a 10-year.
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Will softer inflation persuade the Bank of Canada to hold interest rates?
Softer than expected inflation in August has prompted leading analysts to suggest that the Bank of Canada should perhaps hold interest rates steady during the coming months.
Statistics Canada reported last week that the headline inflation rate was 1.7% in August on a year-over-year basis, while month-over-month consumer prices slipped 0.1%. Meanwhile, the core rate — which strips out volatile-priced items such as food and energy — remained unchanged at 1.6% in the month. Market consensus was for a headline rate of 1.9% and a core reading of 1.7%.
The figures indicate inflation poses no threat to the economy, and at present consumer price increases are running below the Bank of Canada’s forecast. For instance, analysts indicate the core rate — which the central bank closely watches because it excludes volatility — will come in lower than the Bank of Canada’s forecast for 1.8% in the third quarter of 2010.
Taking into account that the central bank sets its policy rate in an effort to attain and maintain 2% inflation, these figures have analysts suggesting that the Bank of Canada might refrain from raising its benchmark rate again at its next meeting on Oct. 19.
The Bank of Canada has raised rates by 25 basis points at each of its last three meetings, as Canada recovered strongly from the recession. However, growth has ebbed as of late, due to a slowdown in the U.S. and global economies. Second-quarter GDP expansion was 2% annualized, down from the 5.8% reading in the first three months of 2010.
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