Pace
slows but remains respectable
By Dr. Peter Andersen
Canada's economy has slowed but it is still advancing at a respectable pace.
Net exports are a drag on activity and automotive and industrial product exports
are slumping. However, domestic markets (retail, wholesale and housing) remain
strong. Real GDP growth will be around 2.5 per cent through the first half
of this year, up from 1.7 per cent late last year. The economy is operating
slightly below its full production capacity.
Consumers and businesses
confident
Consumer confidence is flat to down slightly but still remains upbeat, according
to recent surveys. Big-ticket buying plans remain high and home buying intentions
are still strong. There are mixed signals for business confidence though.
On the positive side of the coin, companies report that they expect continuing
strength in domestic sales and the ones that export indicate that their currency-related
concerns have eased somewhat. Intentions to spend on machinery and equipment
remain upbeat - in line with last year's positive results.
"The unexpected weakness in housing starts in early 2005 is centered in the single-detached category."
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Stable
Interest Rates
Private sector hiring declines
The problem is that this does not fit what is actually happening in the job
markets. There has been persistent weakness in private sector payroll employment,
which is being masked by gains in public sector jobs and self-employment.
Private sector employment is now actually lower than it was last fall. Nonetheless,
earlier gains still mean that employment is running at a reasonably elevated
level.
This will be an important indicator to watch. If the recent pattern of weak
private sector job growth continues, this could cut into home buying and renovation
plans later this year. Employment growth has always been a good indicator
for future directions in consumer confidence.
Building permits shaky
Building permits are a leading indicator for housing starts. There has been
volatility in building permits recently but the trend is giving a warning
sign. Residential permits were down sharply in March and the seasonally adjusted
first-quarter monthly average is below the previous quarter. On a year-to-date
basis, though, the total value of single-family permits issued in the first
three months of 2005 is still substantially higher (+8.0 per cent) than in
the same period in 2004. The March decline mainly reflects weakness in Ontario
and Quebec.
Inflation
under control
The surge in energy costs has not spilled over into general inflation either
in Canada or the United States. The core measure of consumer price inflation,
which shows the underlying trend, is running at 1.8 per cent. This is comfortably
below the Bank's 2.0 per cent target.
Wage inflation remains low with increases in average hourly earnings in the
2.25 per cent to 3.25 per cent range since last summer. The proportion of
firms reporting labour shortages, or difficulties in meeting an unanticipated
increase in demand, is also lower than average.
The Bank of Canada is predicting a core rate of CPI inflation of around 1.7
per cent through the rest of 2005. This is good news for Canada's new home
builders and renovators as it points to a low and stable interest rate environment.
Favourable
credit conditions
In the U.S., the benchmark yield on the 10-year U.S. Treasury note has edged
lower again and is currently yielding only around 4.20 per cent. This is having
an important restraining effect on Canadian bond yields and, therefore, on
longer-term Canadian mortgage rates.
There was a small increase in mortgage rates in March but this was reversed
in April. Quoted rates for a one-year closed mortgage are currently around
4.90 per cent and, for a five-year mortgage, around 6.05 per cent. This means
that, after discounting, one-year mortgages are available for around 4.15
per cent, and five-year mortgages for around 5.00 per cent.
For those daring enough to consider a convertible mortgage, the effective
rate would be 3.75 per cent. The message is that interest rates are still
remarkably low and highly supportive for housing demand. This is a key reason
we expect stable housing starts in the second and third quarters.
Detached starts a problem
The unexpected weakness in housing starts in early 2005 is centered in the
single-detached category. On a year-to-date basis, single starts in urban
areas are down by 10 per cent year-to-year in the January-April period. Multiple
unit starts are also down year-to-date, but only by one per cent.
The weakness in single-detached starts is not evenly spread out across Canada.
The Prairies actually show gains. Manitoba, Saskatchewan and Alberta all show
increases in single-detached starts. The Prairie region shows an overall year-to-date
single-start increase of nine per cent. The weakness is concentrated in British
Columbia, Ontario, Quebec and the Atlantic Region, which all show double-digit
percentage declines in single starts: 17 per cent, 15 per cent, 15 per cent
and 10 per cent, respectively.
Fundamentals
remain positive
There is an increasing concern in Canada about an impending downturn in residential
construction. Single-detached starts have been surprisingly weak. The big
drop in Ontario is something to worry about. However, supply constraints may
be partly responsible. Municipalities are reported to be slow in processing
applications. Environmental and sewer/water servicing issues are also supply
constraints.
At this point we are not going to lower our 2005 national forecast of 215,000
starts as the fundamentals for housing demand remain positive. Consumer confidence
is holding at a high level and mortgage rates remain very low. The "soft
patch" that the U.S. economy is going through will keep longer-term interest
rates low and stable on both sides of the border. Also, renovation activity
continues to show outstanding growth. Retail sales at building and outdoor
home supplies stores showed more strength than any other retail sector in
February with a year-to-year gain of 12.5 per cent..
HB