Canada set to grow in different ways

The Canadian economy is poised to grow again, but in a very different way according to the Bank of Canada’s (BoC) recently-released Monetary Policy Report.  The BoC expects global economic growth to strengthen…. gradually… and modestly.

Once again, the U.S. market is impacting growth in Canada. While there is demand for our exports, US residential investment and investment in their oil and gas sector, which are key sources of demand for Canadian exports, has changed.  Economic activity there expanded at a modest pace at the end of 2015 and the beginning of 2016, and while it was hoped that there would be strong momentum, it hasn’t happened.  Growth is expected to remain modest for the year.  Not surprising given it’s an election year.

The Loonie
The battered loonie has been showing signs of life. It recently hit 79.50 cents US at one point during the last week in April -- its highest mark since July 2015.

Global economies
Unfortunately, economic recovery in the euro area and Japan continue to yo-yo. Low oil prices and exchange rate depreciations have dampened growth.  In the euro area, growth is also being restrained by ongoing deleveraging, weak investor confidence and tight lending conditions. In Japan, lackluster wage growth is restraining consumption.

China
The economy there is in transition with movement away from industry and more towards the service sector, which now accounts for just over 50% of China’s GDP.  China’s GDP growth is expected to slow from 6.9% in 2015 to 6.3% in 2018. Fiscal stimulus is expected to be focused on additional infrastructure spending and tax relief for businesses

Canadian Economy 
The inflation rate is projected to stay below 2% through 2016. Core inflation is expected to be around 2% through 2017. The economy is also in transition, moving toward non-resource sectors.  This adjustment is expected to contribute to the moderate growth cycle we are now in for the next two years.
 However, it’s not all bad news.  Economic activity through 2016 and 2017 has been revised up, thanks to measures introduced in the federal budget in March.  The gap between growth and activity is likely to close sometime in the second half of 2017. This adjustment period is expected to last until 2019.

The Housing Market
New construction and activity in the resale market is strong in British Columbia and Ontario, relative stability in Quebec and the Maritime provinces,  although there are declines in housing activity in  oil-producing provinces. The strength in British Columbia and Ontario appears, in part, to reflect local demand stimulated by employment growth. The shift in interprovincial migration in response to the oil price shock is reinforcing the regional divergence in housing market activity as workers leave the oil-producing provinces for Ontario and British Columbia.

The strength of housing demand in Ontario and British Columbia is contributing strongly to growth in residential mortgage credit.

The BoC continues to keep its overnight rate at .05%. Stephen Poloz, President of the BoC, defends his monetary policy and said, “The fact is that policy actions -- monetary and fiscal -- taken in the wake of the global financial crisis, prevented what would have been a second Great Depression. But many of the negative forces that were acting then are still acting now. That’s why ultra-low interest rates are not causing rapid growth and inflation.”

There will be lots to watch in the upcoming year as the world transitions. What that will look like is anyone’s guess.

A sobering look at the economy

Everyone is waiting for the Liberal government’s new budget on March 22. Prime Minister Justin Trudeau has promised to run deficits in the coming years because billions will be spent on projects like infrastructure, which he predicts will create jobs and help revive the economy. There are also other economy-boosting plans such as cutting taxes for middle-income earners, which has already happened, and revamping child benefits so they help more families.

A brief overview of the current state of the economy is evidence that the country is in a slow growth period, with the exception of housing.  First, the value of the loonie is dragging and clearly the Bank of Canada (BoC) does not have the power to do anything about it.

The latest rate announcement from the BoC left the overnight rate unchanged at 0.5%.  One reason may be that a rate cut would continue to heat up consumer credit and housing activity and could potentially increase household debt. The average Canadian household carries $1.65 in debt for every dollar of disposable income – a record high. According to Statistics Canada consumer credit and mortgage and non-mortgage loans increased 1.2 per cent to $1.923 trillion at the end of last year. The total included $573.6 billion in consumer credit debt and $1.262 trillion in mortgage debt.

Another reason for the central bank’s decision is that it believes it has done all it can to boost the economy. It’s now in the hands of the federal government.

Despite a recent mini-rally, the international price of oil had dropped an additional US$20 per barrel since the Bank of Canada’s last economic outlook in October. The freefall seems to be over, but we need more time to rebalance excess supply with weak global demand.

Finance Minister Bill Morneau has already predicted a deficit of 18-20 billion dollars for 2016/2017. Should we be worried about big defects? Apparently not, according to The Canadian Centre for Policy Alternatives, The organization has urged Prime Minister Trudeau to allow the deficit to rise to $37.9 billion, but to also take steps to get money into the hands of Canadian consumers to stimulate growth. There is a "multiplier effect" of getting more money into the hands of low and middle-income Canadians, who are more likely to spend it.

Yet, once again, the government will be relying on consumers to continue to keep the economy afloat, which it has been doing for the last two years.

The Montreal Economic Institute (MEI) has another view. It doesn’t agree with the premise that increasing budget deficits could boost the economy.

“In the aftermath of the 2008 financial crisis, it is the OECD countries that reduced both their public spending and their revenues that succeeded in achieving the fastest average annual growth,” said Mathieu Bédard, economist at the MEI. "Conversely, countries that chose to increase both their spending and their tax burdens experienced very slow growth.”

However,  the economy certainly needs a boost as we wait for non-energy sectors to kick in. By all accounts the manufacturing sectors in Ontario, Quebec and British Columbia are doing well. There are signs that Canada’s economy is adjusting to new areas of strength in manufacturing, service and technology industries. Those companies are getting a boost from a weaker dollar, and Canada is now a magnet for tourists.

It may still take a few more years for the economy to fully recover and stimulus budgets may help in the interim by speeding up the process.

We can only wait to see what the Federal budget looks like and only time will tell if it will work.

Negative interest rates and you

I have a great deal for you – give me $100 and I will give you back $99. No? Well, that would be the result of a negative interest rate scenario The Bank of Canada’s  (BoC) Stephen Poloz has alluded to as an option  in case of another global  economic crisis. We’re not there yet and it is unlikely we will ever get there, but if we did, it’s not likely consumers would be impacted in a big way.

So what would happen if we had sub-zero interest rates? First of all, that loan deal presented at the beginning of this article would be the scenario for the banks. When you put money into a deposit account, you earn money on that deposit. For example, if you deposited $100 and 0.5% interest rate, you end up with $100.50. A negative interest rate works the other way. If you deposited $100 at a negative 0.5% interest rate, you would end up with $99.50.

If banks were to keep borrowing from the BoC, they would be paying for the privilege of doing so. The idea is to force the banks to be more liquid. Instead of saving, they get a financial return by using more of their funds for loans.

It’s not a “normal” response to an economic crisis but a few countries have gone there recently – Denmark, Sweden and Switzerland, for example. The BoC has other tools and the new government is working on a stimulus package that will likely help get the country growing again.

Loans may cost less but loans wouldn’t necessarily be easier to get -- consumers would still have to qualify. And unlike in Denmark, where some banks are paying mortgage holders a small monthly interest on their home loans, that is not likely to happen here.  Also, if rates did go sub-negative, it likely wouldn’t mean added banking fees for saving-account customers either.  If that were to happen, consumers would just hoard their cash.

“The lower rates go, the more likely you are to spend,” said Carlton University economics professor and monetary policy expert Nicholas Rowe in an interview with Global News. And low interest rates stimulates the economy because, “it’s a big encouragement to go out and spend your money,” he added.

As for mortgages, the variable rate might be affected but fixed rates are depended on the bond market.  In fact discounts from prime on variable mortgages have actually decreased significantly in recent weeks. Encouraging home ownership is good for the economy overall because when people buy homes, they also buy other goods for that home.

There are two reasons to cut interest rates: to stimulate the economy through increased borrowing and consumption and to devalue the currency to boost exports.

There may be some good news on that front.  Many Canadian economists expect good news in the upcoming months.  Although it has taken longer than expected for the economy to depend less on the oil sector and more on the manufacturing sector, growth is expected in 2016 and 2017.

A lot is riding on the federal government’s new stimulus package, aimed at kick-starting a sluggish Canadian economy. Although the details have not yet been released, BMO Capital Markets thinks it will lead to economic growth. They crunched the numbers and say, at best, “stimulus would lift GDP growth by a bit more than 0.5% next year.”

If so, BMO’s call for just over 2% economic growth in 2016 and 2017 edges a bit higher to 2.5%.
Although it’s not likely we’ll see negative interest rates, it’s good to know there is a plan in place, just in case.

What to make of the economy, interest rates, house prices and debt

Here are the facts at this moment in time: The growth of the Canadian economy continues to struggle in the wake of lower oil prices and a dropping loonie. 

Interest rates are at historic lows. The Bank of Canada’s prime interest rate is now at .75%. The prime lending rate for consumers is 2.85%. Five-year fixed mortgage rates are between 2.64% and 2.79%. Five-year variable rates range from 2.15% to 2.3%.

House prices have spiked in a few hot spots across the country — most notably Toronto and Vancouver where prices have risen 10% and 11% respectively  — which is skewing the national average.

Household debt is sitting at 163.3% as a percentage of disposable income according to Statistic Canada's recent report -- only marginally lower than the record 163.9% ratio the agency reported in the fourth quarter of 2014.

Should Canadians be concerned about their jobs? Will interest rates start to rise soon? Will there be a housing meltdown? Is household debt out-of-control?

Let’s see. The Bank of Canada’s (BoC) Governor Stephen Poloz, in his latest statement, was clear about one thing — he was confident that the regulatory changes to mortgage lending was working and those taking on mortgages were able to pay them. So, as far as interest rates, it’s pretty safe to say, barring any major economic upheaval, that low interest rates are here to stay until the economy starts to grow.

The Chair of the US Federal Reserve Janet Yellen announced recently that interest rate hikes are coming. Yellen said if the American recovery continues, rates with rise this year. As the US economy starts to pick up steam, then Canada’s economy will likely follow. 

At this time consumers are taking advantage of low rates to pay down mortgage debt. A recent survey by Manulife Bank of Canada found that 40% of homeowners are starting to pay off their mortgages ahead of schedule. Manulife found that 18% made extra lump-sum payments in the past year, while 17%  increased their regular payments which reduces amortization. Another five per cent did both.

The annual survey of home buying habits by the Canadian Association of Accredited Mortgage Professionals (CAAMP) finds the same thing. CAAMP found that  first-time buyers are, on average, putting 21% down and expect to tighten up amortization periods from 25 years to 20 by increasing their payments.

If Poloz was truly concerned about debt then raising interest rates would quickly nip that worry. But raising interest rates would not help what Poloz sees as a bigger concern —  weak exports and business spending. Basically, Canada’s economy is stagnant. What the BoC does monitor closely is the rate of inflation, which it aims to keep between 1% and 3%. If it starts to edge closer to the 3% rate, then we can expect some changes. The current inflation rate is hovering around the 2% mark. 

House price increases may still be a concern; however, there is evidence that prices are stabilizing. According to the Canadian Real Estate Association (CREA) only half of Canadian provinces can expect house prices to increase.

Canada Mortgage and Hosing Corporation (CMC) recently reported that while there are some concerns about overheated regional markets, the overall national risk remains low.

While newspaper headlines tend to be somewhat controversial, the reality is that many Canadians are getting better educated financially,  are putting themselves in stronger financial positions and are more resilient to whatever is happening in the country.

The Growth of the Canadian Economy

When Bank of Canada (BoC) Governor Stephen Poloz lowered the prime interest rate to .75% earlier this year in response to what he called the “effects of the oil shock” it came as a surprise to economic pundits and economists alike. Many thought the central bank would hold off on moving the rate until late 2015 or early 2016, with the next adjustment expected to be a hike.

"We have an oil-price shock, which will reduce the income flowing into Canada and lead probably to some increase in unemployment overall," Poloz said.

Until the “oil shock”, Canada seemed to be headed for some post-recession growth. Still, Poloz said he was encouraged by signs of economic life, particularly in Canada's non-energy sector, thanks to a low loonie and strong U.S. growth.

Yet, we still hear about housing bubbles and overvalued real estate. It’s true that house prices in many markets are on the upswing especially in the country’s two hottest markets -- Vancouver and Toronto.

However, the Spring market has turned out to be surprisingly strong and ReMax revised its house price projections upward last week citing high consumer confidence and low inventory. There are even bidding wars in some markets surrounding the “Big Two” – like Hamilton and Barrie in Ontario and in Victoria B.C.  And while in Calgary, the housing slump is evident (oil shock fallout), the Edmonton market is showing resilience.

There was talk that Poloz might lower the prime interest rate again, which did not happen. Poloz said the January interest rate cut was enough to support the nation’s economy as it recovers from the slump in oil prices. Total inflation is at 1%, reflecting the drop in consumer energy prices. Core inflation has remained close to 2%.

So what does that all mean for the Canadian housing market? At this time, little of what has occurred has had an adverse affect on the housing market in most areas of the country. Is there a housing bubble? Well, we have been hearing about a potential housing crash since 2010 – if it was going to happen, it likely would have happened by now.

During these past four years, the government has imposed tighter restrictions to mortgage qualifications and mortgage products, which have altered the lending landscape, and which appear to have prevented a housing collapse. As always, there will be doomsayers.

A better thought is to look at all the positives in the economy starting with the latest Bloomberg Nanos Canadian Confidence Index. According to the results of its recent telephone poll, Canadians are optimistic about real estate, with consumer confidence the highest it’s been in three months. Homeowners are more confident than renters.

When we review the recent federal budget, there are more positive signs for housing and the economy. For one, it was a balanced budget and the government is projecting a surplus of $1.4 billion dollars. Seniors get a new tax credit for home improvements to improve accessibility. Small business gets a tax rate drop to 9% from 11% over the next four years. Manufacturers get a tax break. And the budget held off on any new measures to cool housing.

“There has been an appropriate and desirable moderation in housing activity in most regional markets across Canada. Toronto and Vancouver, in contrast, have continued to experience periods of strong sales and price growth, with housing market strength in these cities supported by such factors as population growth and land scarcity,” according to the budget.

This, despite the fact that household debt levels have reached record levels, again.

Also, when we look at the news coming out of some key sectors, this is what we find:

•  Real gross domestic product (GDP) by industry increased in every province and territory except New Brunswick, Newfoundland and Labrador and Yukon in 2014. Nationally, real GDP by industry rose 2.4% in 2014. (Stats Canada)

• Employment increased by 29,000 in March. The unemployment rate was unchanged at 6.8%.

• Oil prices are showing signs of improvement and so is the loonie. (Stats Canada)

•  Average wages have grown by 2% over the past twelve months, which means that incomes are rising a little faster than the average price growth, as measured by the Consumer Price Index (CPIP), which stood at 1% in February. While not spectacular, this signals a small expansion in the purchasing power of the average Canadian worker. (TMG’s David Larock: http://www.movesmartly.com/2015/04/how-will-the-latest-employment-data-affect-canadian-mortgage-rates-april-13-2015.html )

• Canadian housing starts rose much more sharply than expected in March as groundbreaking on new condominiums and apartments in urban areas surged 48.2%. (CMHC)

•  A robust U.S. economy will ensure that slow growth will not be Canada’s new normal (Fraser Institute)

All of this good news in the Canadian economy trumps the small news and makes Canada a growing, stable economy that can weather short term fluctuations for a strong and prosperous future.