Economics Blog Posts

The April 2013 Bank of Canada monetary policy report (MPR) included a significant lowering of the Bank's growth and inflation forecast from their previous projection in January:




Lower economic growth means that the Bank does not expect the economy to return to its potential (or full-employment) level until sometime in 2015. It's worth noting that the Bank has been consistently optimistic about when the economy's output gap (the difference between economic output produced with fully utilized resources and what the output is currently being produced) will close and indeed, given a lower growth forecast, the output gap is actually widening rather than shrinking. With an expanding output gap and inflation trending well below its two per cent target, it is natural to ask if the next move by the Bank of Canada is a rate cut rather than the rate hike that almost all economists have penciled into their forecasts. Economists tend to evaluate the ‘rightness’ of monetary policy using estimated policy rules. That is, a formula for setting interest rates in a way that is consistent with the goals of the central bank. In the Bank of Canada’s case, that means stabilizing inflation around a target rate of two per cent. Using an interest rate rule that closely matches past Bank of Canada rate-setting behaviour, along with the most recent Bank of Canada forecast, we can see that the interest rate path that gets inflation back to two per cent is still consistent with the next rate move being up.



Besides that, the Bank is also unlikely to lower interest rates since doing so would run counter to a year of loudly exhorting households to cut back on debt. Instead, the Bank will likely continue to use forward guidance about the need, or lack thereof, for future rate hikes in order to influence long-term rates and the Canadian dollar lower. The combined effect of which should provide continued stimulus to the Canadian economy over the following year.

In a recent blog post, economists at the Canadian Conference Board wrote about the strong impact that the Chinese economy has on the Vancouver housing market. The analysis done by the Conference Board suggests that while Chinese GDP is uncorrelated with Vancouver employment, it is correlated with Vancouver housing variables. This would suggest that economic growth in China is not a significant driver of local economic growth, but is a direct driver of the housing market.

While we agree that the Chinese economy has an impact on the Vancouver market, we would argue that the impact is far less direct than implied by the Conference Board. The British Columbia economy has the greatest exposure to China of any Canadian province, both directly since China is BC's second most important export market, and indirectly via China's impact on commodity prices relevant to BC. Faster growth in China is good for BC and good for Vancouver as higher exports, manufacturing output, and commodity prices drive gains in capital investment, incomes and employment - all of which will in turn spur the housing market.

What is missing from the Conference Board's post is how large an impact Chinese economic growth might have on Vancouver home prices and sales. One way to discern this impact is to simply let the data speak for itself though a simple Vector Autoregression (VAR) of Chinese GDP growth and real Vancouver home prices and home sales. A VAR allows us to trace the dynamic impact of a shock to the Chinese economy (meaning a positive or negative unexpected change in the rate of GDP growth) without forcing a lot of structure onto the underlying relationship. Running this simple VAR, we can see that the direct quantitative impact appears much smaller than hinted at in the Conference Board's analysis.  

The above analysis is hardly definitive, but it does suggest that while Chinese growth is certainly a factor to watch given the importance of China to the BC economy, it is far from being the primary driving force behind the Vancouver housing market.

With 12 full months of economic data available, it is time to update BCREA's tracking estimate for 2012 economic growth in BC. As background, provincial economic data is available at an annual level only and with a very long lag. Therefore, the BCREA economics team has developed a monthly growth tracker to estimate monthly growth in BC real GDP. As shown below, our growth measure has accurately captured actual BC real GDP growth over the past decade.

Looking at our tracking estimate, the BC economy started the year strong, with momentum carrying over from 2011, before sharply decelerating in the back half of 2012. According to our estimate, annual real GDP growth trended under 2 per cent in the fourth quarter of 2012 and averaged 2.3 per cent for all of 2012. We anticipate that slow growth will continue in 2013, with the provincial economy expanding just 2.2 per cent.

Over the past four years, policymakers in Ottawa have deemed it necessary to restrain mortgage credit with the most impactful change coming from a shortening of amortizations on high-ratio mortgages from 40 to 25 years. While some tightening of lending standards was prudent in the wake of the US sub-prime fiasco, the rationale provided by the federal government has not always been air-tight, particularly when it comes to Vancouver. When explaining the need for tighter mortgage lending standards, it is common to hear the Finance Minister cite the “overheated” or “red-hot” Toronto and Vancouver condo markets. For those of us that pay attention to the Vancouver condo market, these thermogenic metaphors can be puzzling. Pictured below are condo prices in Vancouver from 2008 to the present, adjusted for consumer price inflation.



As is clear from the chart, since recovering from the panic of the global financial crisis, inflation adjusted condo prices in Vancouver have actually been trending lower since 2009. The same story holds for condo sales, which cratered during the financial crisis, posted a strong recovery, and have fallen well below pre-crisis levels since.

An objective look at data clearly shows that the Vancouver condo market has not been “hot” for quite some time. Perhaps it is time for federal policymakers to update their talking points.

While there were a number of ups and downs in the Canadian mortgage market in 2012, there was very little movement in mortgage rates. In fact, the volatility of mortgage rates, as measured by a rolling 52-week standard deviation of the 5-year fixed rate, reached at least a 32 year low in 2012.

 

With growth and inflation remaining relatively subdued and the Bank of Canada on the sidelines for much of 2013, the unprecedented low volatility in Canadian mortgage rates is likely to continue for much of the new year.

Statistics Canada’s annual publication of Provincial Economic Accounts was released earlier this week. This publication includes the final estimate of GDP by province for 2011 and so provides a final estimate of economic growth in the provinces. BC real GDP expanded 2.8 per cent in 2011, close to BCREA’s estimate of 2.7 per cent, and a slight deceleration from 2010’s rate of 3.2 per cent.  Household consumption spending accounted for 1.5 per cent of overall growth while business investment accounted for 1.3 per cent. In spite of a strong year for BC exports, the province still had a net trade deficit which subtracted over 1 per cent from real GDP growth.

BC ranked fourth among the ten Canadian provinces, with resource rich provinces Alberta and Saskatchewan leading the way, posting fairly remarkable growth of 5.1 and 4.9 per cent respectively.  The rankings continue to show a westward shift in the economic engine of Canada, with the four of the top five fastest growing province located in Western Canada.

The Federal government has tightened mortgage regulations four times since 2008, with each intervention followed by a sharp decline in home sales. The most recent intervention was implemented in July 2012 and primarily involved a reduction of the maximum Canada Mortgage and Housing Corporation (CMHC) insurable mortgage amortization period from 30 years to 25 years. As with prior interventions, BC home sales have sharply declined in the immediate months following the change in policy.

There are a myriad of factors influencing the decision to buy or sell a home and the mortgage policy changes the government instituted differed in scope and impact. However, the pattern in the chart above does seem to indicate that the weakness in home sales that followed each tightening of mortgage regulations was not a coincidence. In fact, if we try to extricate the impact of mortgage tightening via multiple regression analysis (controlling for mortgage rates and provincial economic variables), we find a statistically significant and negative immediate impact on homes sales in the order of seven per cent. That is, on average, monthly home sales were seven per cent lower in the month following the change than they would have been absent the implementation of tighter mortgage regulations. Moreover, the effects of tighter mortgage credit tend to persist for many months following the change, deepening in the first few months before fading over time.

Much of the BC housing market was already softening before the new amortization rules were implemented, but the change clearly gave the market an extra nudge downward. Given decent economic fundamentals, we expect sales to come off current lows as the effects of the policy change fades in coming months. Until then, sales in some parts of the province will likely remain well below seasonal averages.  

The Bank of Canada remains caught in a delicate balance. The trajectory of the output gap and the stickiness of consumer prices would under normal conditions, and under conventional monetary economics (see chart below), have pushed the Bank towards tightening interest rates. However, potential interest rate increases have been deferred by a near crisis environment in Europe, a stop-and-go US economy, and perhaps most importantly, the highly indebted position of Canadian households. 

A slowing global economy and a high dollar continue to exert pressure on Canadian exporters. Furthermore, while the Bank has carefully communicated that US monetary policy will not determine Bank of Canada rate actions, the explicit stance of the US Federal Reserve to keep interest rates low past 2014 does somewhat constrain the Bank’s ability to raise interest rates without putting further upward pressure on the loonie and harming much needed export growth.

In terms of the domestic economy, the Bank has been consistently exhorting Canadian businesses to spend and households to save. In a best-case scenario, consumers would be de-leveraging while businesses invested in productivity enhancing capital. This would facilitate a necessary shifting of the burden of growth from consumers to Canadian firms.

A scenario of consumer de-leveraging paired with ramped-up business investment and export growth will require interest rates to remain low. That said, the Bank is also serious about maintaining its mandate of price stability and is increasingly indicating a desire to move rates off of historically low levels. Balancing these objectives will require a delicate fine-tuning of monetary policy which we expect to proceed cautiously, perhaps with a rate-tightening of 25 to 50 basis points beginning in early to mid-2013. A slight increase in interest rates would allow the Bank to signal to households that higher interest rates are on the horizon while still maintaining a substantial degree of monetary stimulus to encourage business investment.

In a widely anticipated move, the US Federal Reserve announced yesterday that it will conduct a third round of quantitative easing (QE). The primary difference between QE3 and the Fed’s previous two quantitative easing programs is that QE3 asset purchases are open-ended and, most importantly, will continue until there is a substantial improvement in US labour market conditions. That is, the Fed has tied the duration of its latest program of asset purchases to an explicit macroeconomic objective. The Fed also extended its commitment to keep its target Federal Funds rate at near zero levels through at least mid-2015.

The theory underlying quantitative easing is that asset purchases will stimulate the economy by lowering long-term interest rates, including interest rates on mortgage debt, thus encouraging investment while giving a much needed jolt to the US housing market. While the evidence for the impact on growth and employment from past QE programs is mixed, pairing open-ended asset purchases and a commitment to keep interest rates low for an extended period with a specific objective has much support in academic literature.

The implications of the Fed’s announcement for Canadian interest rates are two-fold. One, the commitment by the Fed to keep interest rates at near zero levels until mid-2015 further constrains the Bank of Canada’s ability to raise interest rates over the same period. Particularly as Canadian exports have already softened under the weight of an appreciating loonie. Second, already low long-term bond yields will likely price-in a continuation of very low short-term rates and will therefore likely remain at historically low levels for an extended period which should keep Canadian mortgage rates well anchored to current historically low levels.

With most of the media attention focused on the Vancouver and Toronto real estate markets, it is easy to miss some of the truly good news stories like the surging real estate markets of Northern BC. So far in 2012, sales through the BC Northern Real Estate Board have risen 14 per cent while average prices are up over 5 per cent.

A big reason for the strength of northern housing markets is of course rising commodity prices and consequential investment in oil and gas and mineral exploration and production. Moreover, BC's long beleaguered forestry industry is starting to find its footing thanks to growing trade partnerships with emerging Asian economies. Increased investment and exploration in the natural resource sector in BC has lead to a strong recovery in employment in Northern BC, which of course stimulates demand for housing.

 

As demand for BC's natural resources from Asian markets continues to expand in the future, employment growth and housing demand in the north should remain strong.

 

When the Bank of Canada announces its interest rate decision tomorrow morning, it will no doubt choose to keep its target overnight interest rate at 1 per cent where it has been held for the past 23 months. 

The main point of interest for Bank watchers will be whether the language accompanying the decision is tempered from previous statements that had the Bank tipping its hand towards a more hawkish stance. Indeed, with recent changes to mortgage lending rules acting as an approximately 1 per cent targeted rate hike on the housing sector and ongoing global economic uncertainty, it is hard to imagine that the Bank has been pushed any closer to tightening policy. 

Our modeling suggests that the Bank will lower its official forecast for Canadian economic growth from 2.4 per cent to 2.1 per cent in 2012 and from 2.4 per cent to 2.3 per cent in 2013. This implies that the output gap, a key indicator for the future tightening of monetary policy, will not close in the first half of 2013 as the Bank had forecast in its April Monetary Policy Report. Therefore, while we still expect that the next move on interest rates will be up, we do not expect rates to rise until near the end of the first quarter of 2013. 

Tracking the performance of the BC economy is enormously important to any analysis of the provincial housing market. However, data for provincial GDP growth is only released annually and at a significant time lag which is why the economics team at BCREA has developed a tool to track economic growth on a monthly basis. Using a statistical method called principal components analysis we can summarize large amounts of economic data into one convenient measure of the economy. Our tracking index combines 30 provincial economic indicators into a single monthly measure that tracks growth in BC Real GDP.

Now that we have four full months of economic data available, we have updated our tracking estimate of annual real GDP growth through April to 2.8 per cent. Note that we have seen some slowing of growth of late which is in line with our official BCREA economic forecast of 2.5 per cent growth in the BC economy for 2012. 

 

For the fourth time in the past four years, the Federal Government has announced further action to restrict mortgage credit. The new measures include:

• The maximum amortization on a prime mortgage will be reduced from 30 to 25 years.
• Mortgage insurance will not be provided for properties valued over $1 million.
• Refinancing has been lowered from a maximum of 85% loan-to-value to a maximum of 80% loan-to-value.
• The maximum gross debt service (GDS) and total debt service (TDS) will be limited to a maximum of 39% and 44% respectively. Currently, GDS does not apply to qualified borrowers with credit scores over 680.

These measures will take effect July 9, 2012.

Implications for the BC home market:

• The new 25 year amortization will have a small but material impact on affordability for homebuyers. For a $300,000 mortgage, the shorter amortization period will add over $150 per month to mortgage carrying costs for homebuyers that would have instead opted for a 30 year amortization. This is equivalent to an approximately 1 per cent increase in mortgage rates.
• Longer amortization period may also impact the rental market where investors have utilized longer amortization period to lower carrying costs.
• Prohibiting mortgage insurance for properties over $1 million will impact Vancouver markets to a much greater extent than other Canadian jurisdictions. While this policy may have limited impact on credit access for high-ratio borrowers, it will tighten credit for the $1 million and over segment of the market through its impact on lenders risk management practices. This is particularly true in light of the CMHC already rationing portfolio insurance for low-ratio mortgages.

Canadian retail sales declined 0.5 per cent in April, offsetting a similar increase in March. Weakness in the retail sector was broad-based with 8 out of 11 retail sectors recording declines. April was a particularly difficult month for new car dealers and clothing retailers which saw declines of 1.4 per cent and 2.8 per cent respectively. The retail sector in BC also had a disappointing month in April. Provincial retail sales fell 0.2 per cent while year-over-year sales growth decelerated to a modest 2.3 per cent.

With two full months of economic data now reported for the second quarter, we have revised our Q2 tracking estimate of Canadian GDP lower to 2.4 per cent following first quarter real GDP growth of just 1.9 per cent.

What is going on with Vancouver home prices in 2012? Well, it depends on who, or rather which measure of prices, you ask. The chart below shows four measures of home prices: the MLS® Average Price, the MLS® Median Price, the MLS® Home Price Index (HPI), and the Teranet-National Bank Home Price Index.

As is plain to see from the chart, the MLS® average price for the Real Estate Board of Greater Vancouver (the price that the BCREA reports each month) diverged sharply from other measures of Vancouver home prices sometime in 2010. To see why this happened requires a little bit of statistics. The average price is calculated simply by summing sales volume and dividing that total by the number of units sold. If sales are distributed normally so that sales are reflective of the existing housing stock, then the average price will be similar to the median, which is simply the midpoint of all sales in a given period. However, if a disproportionate number of sales occurred at an extreme end of the distribution, the average will be skewed in that direction. This is exactly what happened through the first half of 2011, as seen in sales activity of homes priced above one million dollars.

Not surprisingly, as sales at the high end have slowed, the distribution of sales has normalized and the average price is no longer being skewed toward the high-end of the market. The fact that the average price is susceptible to changes in the distribution of sales is exactly why other measure of prices that are unaffected by the distribution of sales were developed. The MLS® HPI is estimated based on the individual attributes of homes (such as number of bedrooms, number of bathrooms, geographic area, etc.) and so is a better measure of price changes in similarly appointed homes. Similarly, the Teranet-National Bank home price index uses a repeat sales methodology that compares the change in prices of homes that have been sold at least twice. Looking at these measures of Vancouver home prices we see neither the extreme run-up in prices that occurred in early 2011, nor the recent decline.

When trying to get a handle on any market, it is best to use as diverse an amount of information as is available. Looking at the four major measures of Vancouver home prices we would conclude that while prices are moderating in part because of slower sales activity, much of the decline in the MLS® average prices is due to the normalization in the distribution of sales.

April was a big month for employment gains in the BC economy with close to 20,000 new jobs, including 16,700 full-time positions. The provincial unemployment rate, which can be volatile, fell by 0.8 points to 6.2 per cent, the lowest rate since January 2009.

Looking at the industry composition of job growth, most of the employment gains were in the manufacturing industry which continues a trend of strong growth for that sector. Indeed, most new jobs were created in the goods sector of the economy while the service sector was hit by job losses in the FIRE (finance, insurance, real estate and leasing), accommodation and government.

One of the more challenging aspects of tracking the performance of a provincial economy is that provincial gross domestic product data, the best summary of economic performance, are only released annually and with a significant time lag. Although there are a number of provincial economic data released every month such as retail sales, housing starts, and imports and exports, measuring the combined meaningfulness of these releases for economic growth can be difficult. However, using a statistical method called principal components analysis allows us to summarize large amounts of economic data into one convenient measure of the economy and, through some additional number crunching, we can then produce a monthly measure that accurately tracks actual annual growth in real GDP.

Using our tracking measure, we can see the boom years in the middle of the decade, the BC economy slowing in 2008 before collapsing under the weight of the financial crisis and the turnaround started to take shape later in 2009. We also see the burst of growth from the Olympics in the early months of 2010 and the fading of economic growth in the early months of 2011 as global economic uncertainty stifled consumer and business confidence.

Looking at the current state of the BC economy, the province has been experiencing solid growth, likely above 2.5 per cent and trending upwards. As long as this rate of growth holds, BC should start to experience stronger employment growth in 2012 which will help to underpin demand in the housing market.

It is always wise, when gauging market expectations, to remember that the market reserves the right to change its mind and sometimes does so very quickly. To illustrate, here is a chart comparing market expectations of the probability of a 25 basis points change in the Bank of Canada overnight rate by the end of 2012 - observed before and after the latest Bank interest rate decision.

From this chart we can discern that the market believes it is three times more likely that the Bank will raise interest rates before the end of the year, than it did the day before the Banks’ announcement. 

Of course, in terms of impact on the economy or the housing market, it is trivial whether the Bank of Canada decides to raise rates in December or waits a month or two longer. What is important is that the Bank is signalling that its preference is for higher interest rates relatively soon. That preference in turn should translate to an increase in long-term interest rates including mortgage rates, that is, unless something happens to change the markets mind.

The Bank of Canada is expected to once again leave its benchmark rate unchanged at one per cent tomorrow morning. Indeed, the most meaningful thing to watch for in tomorrow’s decision is not the level of interest rates, but the language used to explain the decision. Some expect a slightly more hawkish tone from the Bank given better than forecast Canadian economic conditions and firmer than anticipated core inflation. However, weaker US job growth last month and renewed risk from the Euro-zone, this time emanating from Spain, may keep the Bank from signalling earlier rate increases.

The Bank of Canada is increasing finding itself stuck between stations, without a clear signal on the direction of the economy. On the one hand, signalling higher interest rates would push Canadian households towards the Banks preferred outcome of debt reduction which would ease currently elevated financial vulnerability. However, higher expected rates would also put upward pressure on the loonie, threatening trade growth at a time when the global economic outlook is far from certain.

So, Carney and Company will more than likely elect to punt tomorrow morning, leaving rates unchanged and the tone of its accompanying press release balanced. The Bank will likely revise up its forecast for economic growth this year from its previous forecast of two per cent. However, the economy will not grow at a rate fast enough to spur core inflation beyond what the Bank judges as a tolerable range. Therefore, we do not expect an increase in interest rates before early 2013.

Employment figures released last week by Statistics Canada showed that the BC economy lost 1,700 jobs in March. Given the importance of employment to the housing market, real estate analysts and economists must pay close attention to the dynamics of the labour market. While it is obviously negative when the economy loses jobs on a net basis and positive when the economy adds jobs, what may be less obvious is what makes for a truly strong monthly employment report?

Generally, we would like to see a labour market that is adding jobs at a faster pace than the labour force is expanding. That is, the economy is providing enough jobs to satisfy both new entrants to the labour force, such graduating students and new immigrants, as well as to reduce the current ranks of the unemployed. Over the past ten years, the BC labour force has grown by an average of 1.5 per cent annually. Assuming a similar rate of growth in 2012, we would need to see an average of at least 3,000 new jobs per month just to keep the unemployment rate stable and more than 3,000 new jobs per month to reduce overall unemployment in BC.

Because employment can be buoyed and buffeted by a number of different seasonal and economic factors, it is best not to make too much of one or two months of weak employment data. However, the BC economy has only managed to generate 5,200 new jobs through the first quarter of 2012. This rather anemic pace of job growth that will have to pick-up considerably if we are going to see a boost to consumer demand in 2012 and a pick-up in home sales across the province.