December 7th, 2004

BoC break bodes well for housing market

By Peter Diekmeyer o

Canada's housing market, which had been weakening in recent months on expectations of interest rate increases, got a big break today when the Bank of Canada decided to hold its key rate at 2 1/2 per cent.

The Bank's decision comes after two consecutive meetings in which it announced 1/4% hikes. As recently as six weeks ago, it was hinting that further moves were in the works.

But not only did the bank not increase rates, there is little indication that it will do so anytime in the near future. This should please prospective borrowers and those thinking of entering the housing market.

"I think that it's great news," said Maria Racanelli, vice-president, in charge of personal banking at BMO Bank of Montreal. "Low interest rates have traditionally spurred activity in the housing market, and affect the equation for those who are making the decision about whether to buy or to rent."

Canadian economy and the strong greenback

The Bank of Canada cited the U.S. dollar, which has fallen almost 10% against the loonie during the past month as a key factor influencing its decision. U.S. exports comprise more than 30 percent of Canadian economic production, so any currency fluctuation brings significant economic consequences.
A weak U.S. dollar makes it more expensive for American companies to buy Canadian goods and cheaper for Canadians to buy U.S. products.

"If exchange rates were to persist at current levels, and if all other economic and financial factors were to remain unchanged, there would be a dampening effect on aggregate demand for Canadian goods and services," wrote the Bank in its statement announcing its decision.

The Bank of Canada continues to forecast solid world and Canadian economic growth next year. However uncertainties remain such as commodity prices, further currency realignment and the growing presence of emerging market economies including India and China.

The housing market

Canada's red-hot housing had been seeing signs of weakness in recent months, due to expectations of tighter money. According to the Canada Mortgage Housing Corporation, the seasonally adjusted annual rate of housing starts was 225,000 in October, down from 237,900 in September. The number of housing starts in urban areas dropped in every region except Quebec and the Prairies.

Existing home sales also decreased. According to the Canadian Real Estate Association, 36,263 houses were sold through the Multiple Listing Service during October on a seasonally adjusted basis, a drop of 3.8 percent from September.

But despite the short-term weakness, the full year outlook remains bright. For one, although the number of units dropped, prices remained firm. The average residential price for homes sold during the month of October was a record $232,410, an increase of 7.3%, from October of 2003.

The new construction environment also remains positive. "Favorable economic factors such as recent growth in full-time employment and low mortgage rates continue to stimulate residential activity," said Bob Dugan, chief economist at the CMHC's market analysis center. "Housing starts continue on pace to reach a 17-years high this year."

The interest rate picture remains cloudy

The good news for homebuyers is that the current low-interest rate environment could remain in place for quite a while. Canadian bond markets are currently pricing in stable interest rates all the way through 2005.

But much of whether or not this will occur depends on how the U.S. economy will perform and on how the U.S. Federal Reserve Board will act when it makes its next rate announcement on December 14th. Some experts caution against reading too much into the markets at this point, especially with regards to the long-term picture.

"The Bank of Canada is definitely on hold," said Stéphane Marion a senior economist at National Bank Financial. "But we're not ready to predict that they will be cutting rates any time too soon."

"Growth numbers in the U.S. continue to look strong, and payroll employment has bounced back to almost pre-recession levels," said Marion. "That means U.S. rates are probably going to be rising."

Canadian and U.S. interest rates tend to move more or less in sync and Fed actions are closely monitored by Canadian central bankers.

"I think they are going to stay on the sidelines for several months," Marion said. "But it's still too early to say much more than that at this point."

The Bank of Canada will announce its next interest rate on January 25th, 2005, and will release its Monetary Policy Update two days later.



Previous Bank of Canada action:

Date Action Overnight rate (after announcement)

December 7th, 2004 No change 2 1/2%
October 19, 2004 +1/4% 2 1/2%
September 8, 2004 +1/4% 2. 1/4%
July 20, 2004 No change 2%
June 8, 2004 No change 2%
April 13, 2004 -1/4% 2%


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