Title: Interest rates set to jump again

Sub-title: Surprisingly strong economic data will likely to push the Bank of Canada to hike its policy rate this week. This will have a direct but modest effect on the housing market.

 

Canadian economic data indicate that domestic demand has been surprisingly robust in recent weeks and that the outlook going forward looks good. The latest job numbers were particularly strong and recent surveys show that both business confidence and credit conditions are improving. Experts say that these new developments increase the likelihood that the central bank will hike its key lending rate at its July 20th meeting.

 

“Our base forecast is that the central bank will raise rates by 50 basis points between now and yearend, and will continue with moderate increases into next year,” said Adrienne Warren, an economist with Scotiabank Group, echoing comments made by forecasters at many of the country’s largest financial institutions.

 

Canada’s central bank was one of the first western countries to raise its policy rates as it emerged from recession, due to fears that a too-quick recovery could spark inflation. The move was well timed, says Benjamin Reitzes, an economist with BMO Capital Markets. “Canada’s economy has recovered much faster than that of the United States,” said Reitzes. “Furthermore, unlike the US and China, there is little talk of a possible double-dip recession here.” However rate hikes always raise affordability concerns among housing sector stakeholders. Interest payments are for many Canadians the single largest home ownership cost, and every time they move up, the pool of potential first time home buyers shrinks by thousands.

 

The economy hums along

That said, the brightest spot in the Canadian economy right now is the jobs market. Statistics Canada’s latest Labor Force Survey showed that 93,200 new posts were created during June. That is on top of the 24,700 posts created in May and the 108,700 created in April. Furthermore, almost all of the increase came from private sector jobs, in stark contrast to the United States where recent private sector job creation has been close to non-existent. Jobs are important, because stable employment is the foundation for almost all major categories of domestic demand particularly housing. Private sector jobs are the most important of all, because if enough of those are created, the taxes that new workers pay can also eventually fund new public sector job creation too.

 

The other good news is that Canada’s businesses remain bullish regarding the future. According to the Bank of Canada’s second quarter Business Outlook Survey report: “Overall, businesses are generally positive about their near-term sales prospects, although they are concerned about recent global economic and financial uncertainties and possible spillover effects in Canada.” Business optimism though is tempered somewhat by fears that global uncertainty may have on further expansion, the report adds.

 

In other good news, credit conditions also appear to have improved during the second quarter. According to the Bank of Canada’s Senior Loan Officer Survey, borrowers and lenders all reported that getting credit is now easier, though small businesses, which create the lion’s share of the jobs in the economy, reported no change.

 

Effects on housing

How seriously further Bank of Canada policy rate hikes will affect the housing market remains unclear says Stéphane Marion, chief economist at National Bank Financial. Marion’s team recently estimated that the costs related to buying a home currently exceed the costs of renting a home by 40 percent, which is in line with historical averages. This would indicate that housing is relatively fairly valued right now. Marion concedes that house prices relative to rents are somewhat higher than historical averages. However this is balanced out by the fact that mortgage rates are quite low historically.

 

“We do expect some slowness in the real estate sector, due primarily to the fact that a variety of factore induced many buyers and builders to advance the closing dates of house sales from the second half of the year to the first half. In particular, many wanted to avoid the effects of HST implementation in British Columbia and Ontario,” said Marion. “The market currently expects only 100 basis points in rate hikes over the next 12 months. The impact from those hikes alone should be relatively modest.”

 

Peter Diekmeyer (peter@peterdiekmeyer.com) is a Montreal-based freelance business writer.

 

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