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Economy in Brief

Housing Starts in Canada Begin to Slow As the Central Bank Attacks Inflation
by Robert Brusca  July 18, 2022

This month the Bank of Canada surprised central bank watchers and markets by raising rates by a full percentage point. That increase catalyzed markets beyond Canada, causing investors in the U.S. to begin to wonder if given the inflation statistics in the U.S. would drive the Federal Reserve in the U.S. to make such move. Canada clearly has taken the lead for fighting inflation with its largest rate hike in 24 years. And that naturally begins to have an impact on the housing market although the most recent statistics here are for June and clearly predated the recent move by the Bank of Canada. The implication for housing from that move is that more aggressive moves lie ahead. The five-year mortgage rate was last higher in May 2011. However, five-year mortgage rates we're quite close to these levels back in early-2019. Canadians tend to use variable rate mortgages heavily. One analyst calculated that the new hike will move variable rates into range of 3.35% to 4% and will result in higher monthly mortgage payments of C$323 per months (Source here).

This highlights how different monetary policy is between the U.S. and Canada. Most U.S. homeowners take a fixed rate so that when the central bank hikes rates there is only an impact on new buyers (and of course on sellers since home prices will also be affected in some manner). Variable rates have become much less common in the U.S. However, in Canada, rate hikes work on all variable rate homeowners and impact the household budgets across the country relatively quickly, increasing the potency of monetary policy by affecting the household budget not just the businesses of home builders and home sellers.

The Bank of Canada is hiking rates in an environment where the housing market has been strong as the chart shows and where other economic statistics have also been relatively robust.

Housing starts in Canada are down by 1.6% over 12 months, but they are coming off of three- and six- month periods of rather explosive growth. Permits are lower by 0.9% over 12 months and they have been tempered recently, showing sizeable negative growth rates over six months and three months. House prices, however, have been expanding relatively steadily at double-digit rates over three months, six months and 12 months. Meanwhile the five-year mortgage rate continues to move higher.

Table 1

Table 2 presents a number of Canadian activity statistics arrayed in terms of their ranking on data since January 2021. A low ranking represents a strong reading and a high-ranking number represents a weak reading. In order to make understanding of the table a little more straightforward, all economic data are ranked in a way that causes strong reading is to have low ranking numbers. For example, the unemployment rate is ranked in an inverse fashion as are the number of unemployed. When we see the strongest economic signal from the unemployment rank in May and the strongest signal from the number of people unemployed, what we're seeing is that this ranking represents the lowest readings on the unemployment rate and for the number of people unemployed since those are also the strongest readings.

The table shows a lot of high rankings in May, the most recent month for which most categories have results. Note that manufacturing and mining and industrial production do not have observations yet for May; however, their April rankings were number one in their string of values back to January 2021. Housing starts in May have a rank of five based on their year-on-year growth; in May that was suddenly stronger than what we had seen in the previous five months. Exports and imports also show strong readings indicating strong growth for both of them. There are weak readings, however, for the outlook. The leading economic index from the OECD, whether expressed as an index value or as a 12-month growth rate, shows that its rankings have been slipping steadily over the last six months and are currently the weakest we have seen in this period. That is a sharp counterpoint to the robust rankings across topical data reports.

The far-right column ranks the average of all of these statistics. There we see that when we take these statistics as a group May has the strongest average reading since January 2021, April is the second strongest, March is the fourth strongest, February is the fifth strongest, and so on. Clearly the Canadian economy has been on a strong run. The decision by the Bank of Canada to raise rates sharply during this period is certainly rooted in an observation strength for the economy.

Table 2

In addition, the main statistical gauges for inflation that the Bank of Canada looks at are on their respective highest readings for this period. Canada faces not only growing strength in its economic statistics but also a rising inflation rate. Canada's CPI in May is up by 7.6% year-over-year, the CPI X is up by 6.1%, the core rate is up by 5%. Inflation in each of these measures has been rising steadily and all have risen well above the target for the central bank.

Canada's statistics and its situation fit snugly into the global situation that finds growth still in gear, global inflation high- and accelerating, and central banks acting or needing to act just about everywhere. This week the ECB is finally expected to make its first rate hike. It has been looking at a growing economy and clearly excessive inflation statistics for some time. It also is more wary about the future with its gas supplies dwindling and being cut by Russia and with the war going on in Ukraine. The future is unsure especially because of oil supplies. However, these concerns about the future have clearly delayed the ECB from raising rates even more than the Federal Reserve in the United States was delayed. When central banks delay raising rates for whatever reason, it tends to make the job of getting inflation under control more difficult. The Bank of Canada has acted strongly in July to keep from being put in that position.

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