Home Builder Canada - 2004 Nov.Econ

Higher Canadian dollar a mixed blessing
By Dr. Peter Andersen

Canada's economy is providing a healthy support for new housing and renovation demand. However, the strong Canadian dollar is proving to be a mixed blessing to the construction industry. On the positive side of the ledger, it is having a dampening effect on the prices of imported building materials and supplies. It is also keeping general inflation in check. As a result, the Bank of Canada does not have to push interest rates as high as in previous cycles, when inflation was more of a problem.
The bad news is that the Canadian dollar's strength is increasingly becoming a problem for specific industries. This means that some regions could soon feel the effect in the form of layoffs. Builders and renovators will therefore have to be alert to local market conditions. The strong economy is not evenly spread out across the country. The growth prospects are the best in western Canada. In central Canada and the Atlantic Provinces, the sharp rebound in the dollar is hurting international competitiveness and cutting into company profit margins.
Bank of Canada business interviews carried out in August and September show that nearly twice as many firms report being adversely affected by the appreciation of the Canadian dollar as benefiting from it. The companies benefiting are mainly in the wholesale and retail trade sectors. They are experiencing a substantial dollar-related decline in the cost of imported inputs. The natural resources and manufacturing industries are the most adversely affected.

The need to stay competitive
The latest surge in the Canadian dollar will put extra pressure on Canadian companies to stay internationally competitive. Unfortunately, Canada is falling short in this key performance indicator. The latest global competitiveness report, issued by the World Economic Forum, shows Canada slipping from eighth place six years ago to 15th place today in country competitiveness rankings. The main problem is Canada's poor productivity performance compared to the United States, despite government efforts to boost R&D spending.
Labour productivity has been basically stagnant over the past two years, in contrast to large gains in the United States. With the Canadian dollar now demanding an immediate response by many Canadian companies, the risk is that we could see significant cost cutting and layoffs in specific local markets.

Higher oil prices
Structural changes in the global oil market could mean several more years of relatively high oil prices. There has been remarkably little pass-through of high oil prices into general inflation however. This indicates a lack of pricing power. Firms are absorbing higher input costs on energy and other inputs rather than passing them on.

Bank of Canada Rate increases
The strong Canadian dollar is an important reason why inflation in Canada is running below that of the United States. Inflation has remained well within the Bank of Canada's one to three per cent target range. Overall consumer price inflation is likely to remain lower than in the U.S. and could average around 2.2 per cent in 2005.
Even with inflation staying within its target range, more Bank of Canada interest rate increases are likely. The Bank now believes that Canada's economy is safely on an expansion track and no longer needs interest rates at emergency low-level settings.
The only thing that could deter the Bank from a long series of interest rate increases would be a further large jump in the Canadian dollar or a serious weakening in the U.S. economy.

Housing starts
Housing starts show a consistent pattern of high levels of activity. Given the timelines between starts and actual construction work, this implies a very busy winter building season with a spill-over of work into the spring as well. For suppliers of materials that are used in the final stages of construction, the backlog of product demand is even greater.
There were 231,000 housing starts at annual rates in September. This is exactly in line with the quarterly average for the third Quarter and is just slightly higher than the average rate of 229,000 through the first and second Quarters. Housing starts have remained remarkably stable this year. Compared to last year, they are up by 7.5 per cent on a September year-to-date basis. This puts them on course to total at least 230,000 units for the full year 2004. This would be a 17-year high.

Single-detached starts steady
Single-detached starts have remained remarkably steady not only this year but for almost the last three years. This is very encouraging as many builders do not participate in the high-rise sector, which dominates the multiple category. Single-detached starts in urban areas increased to an annualized rate of 106,200 units in September.
This is one of the highest single-detached start rates this year. It has only been exceeded in two other months. On a September year-to-date basis, single-detached starts in urban areas show a 5.2 per cent increase from last year. The general conclusion to be drawn from this is that Canada's strong housing performance reflects much more than high levels of high-rise activity.
Multiple-unit starts have maintained a relatively high level. At an annual urban area rate of 98,000 units in September, they are in line with this year's average performance.

New home prices
House prices are a more up-to-date indicator of housing demand than starts are. The latest information shows prices remaining strong. The price of new homes was up by 6.0 per cent in August compared to the same month last year. This is the same year-to-year increase as recorded the month before and is not far below the 6.2 per cent increase in June. That was the largest since February 1990.

Regional
Based on house price information, the strongest new housing markets are Victoria, Ottawa-Gatineau and Winnipeg. These cities show year-to-year price increases of 9.1 per cent, 8.6 per cent and 8.5 per cent, respectively. In the most recent month, the largest price increases from the month before were in Saint John, Fredericton and Moncton. Among the largest cities, Toronto and Montreal show increases just slightly above the national average. Vancouver, with prices already very high, shows a 5.5 per cent year-to-year increase in the latest month.

Affordability
These higher price increases have begun to have a small effect on housing affordability. However, new homes are still priced at levels that are well within the financing capability of the average potential buyer. The affordability index is still much healthier than prior to other housing market downturns such as the one in the early 1990's.
One factor that is helping affordability this fall is the unexpected decline in longer-term interest rates in the United States. This is spilling over into Canada and restraining longer-term Canadian mortgage rates. The quoted five-year rate is 6.4 per cent and, after discounting, buyers are able to finance at close to 5.00 per cent.HB