January 25th, 2005

Low rates spur continued strength in housing market

By Peter Diekmeyer o Bankrate.com

Yesterday's Bank of Canada's decision to keep it key rate stable bodes well for the real estate market, which is coming off a year of record listings, re-sale prices and new home construction.

"It's definitely good news," said Sal Guatieri, senior economist at BMO Bank of Montreal. The past two weeks have seen a wealth of year-end real estate industry data pouring in and almost everything is pointing up. Demand for existing homes was strong in almost all major markets throughout 2004. According to the Canadian Real Estate Association full year sales via the MLS system hit a record 316,386 units, an increase of 2.7% over 2003, which was already record year.

Strong housing demand led to big price increases. The average price of Canadian residential home sales rose by 10.1% to $245,149, its fifth straight year of increases.

The tight demand for existing homes also led to significant new construction activity. Housing starts posted a 17-year high, closing 2004 at 233,000 starts, a 6.7% increase from 2003. In addition to low rates, the Canada Mortgage and Housing Corporation cited a tight labor market as key reasons for the increase.

The good news is that low rates are likely to persist for some time to come. The Bank of Canada's decision yesterday means that its overnight rate, which influences rates charged by banks and other financial institutions, remains unchanged at 2 1/2%.

The Bank cited a weaker than expected growth in the Canadian economy and a strong dollar as reasons for its move. However according to Guatieri, the Bank of Canada remains uncomfortable with rates at their existing levels.

Guatieri cites a strong Canadian economy, which is operating at close to full potential, a calmer Canadian dollar, steady rate hikes by the U.S. Federal Reserve Board, and a modest drift upwards in inflation as reasons that that the Bank of Canada will begin nudging rates up later this year.

The Bank's inaction was widely expected by the markets which are currently pricing in a 25 basis points increase in its key rate by late summer and an additional 25 points by year-end. Even if these two increases were to materialize, this would still leave mortgage rates at exceptionally low levels from a historical perspective and when compared with inflation.

Despite the strong full-year housing starts and existing homes sales data, the December numbers were down in both segments, an indication that some of the increases we've been seeing will start to moderate somewhat. Seasonally adjusted housing starts dropped to 234,400 in December from 242,600 in the month before. Existing home sales also tapered off as the year ended, falling 1.7% in December to 25,595 units.

Experts say that the strong long-term real estate market up-trend will likely continue into 2005, but because 2004 was so stellar, year-over-year comparisons will look less spectacular.

"After a year of remarkably strong activity, sales are trending toward more normal levels," said Gregory Klump, the chief economist at the Canadian Real Estate Association. "Less frenzied sales activity will likely encourage many existing homeowners looking to move up." Average price increases will range between 3% and 5% during 2005, with the exception of the spring period, which was exceptionally strong during 2004 Klump said.

New home construction activity on the other hand is unlikely to maintain its torrid pace. The CMHC estimates that housing starts will slide by 9.8% during 2005 to a still robust 210,200 units. Existing home sales made via the MLS system are also expected to fall slightly, but 2005 will still likely be the second strongest year in history.

Another reason for the tapering off in the real estate market is Canadians' increasing indebtedness. According to Benjamin Tal of CIBC World Markets, Canadian households, owe an average of 7% more than they did last year and 20% more than they did at the beginning of the last decade. Much of the rise is to due to the increasing popularity of personal credit lines, with total PCL debt up a whopping 30% during 2004 alone.

The rising debt cost increases households' vulnerability to economic shocks, whether they be a rise in interest rates, an economic slowdown or even a potentially rapid surge in the Canadian dollar Tal wrote in a recent report to clients.

The Bank of Canada's next rate announcement is scheduled for March 1rst, 2005.



Previous Bank of Canada action:

Date Action Overnight rate (after announcement)

January 25, 2005 No change 2 1/2%
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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