The Bank of Canada increased the target overnight interest rate to 1.25%, its highest level since the global financial crisis marking the third rate hike since July. The move comes in the wake of unexpected labour market tightening and strong business confidence and investment. The Canadian economy is bumping up against capacity constraints as the jobless rate has fallen to its lowest level in more than 40 years.

Inflation is just shy of the 2.0% target level and wage rates are rising, albeit at a relatively moderate pace.

Exports have been weaker than expected. NAFTA uncertainty is “weighing increasingly” on Canada’s economic outlook as cross-border shifts in auto production are already beginning.

Consumption and housing will slow due to higher interest rates and new mortgage guidelines. According to today’s Monetary Policy Report (MPR), “growth of household credit has slowed somewhat since the first half of 2017, even though some households may have pulled forward borrowing in anticipation of the new B-20 guidelines related to mortgage underwriting from the Office of the Superintendent of Financial Institutions (OSFI). This slowing is consistent with higher borrowing costs due to the two policy rate increases in 2017.” Home sales increased considerably in the fourth quarter in advance of the tightening OSFI mortgage rules implemented beginning this year.

The MPR goes on to comment that “residential investment is now expected to be roughly flat over the two-year projection horizon. The rate of new household formation is anticipated to support a solid level of housing activity, particularly in the Greater Toronto Area, where the supply of new housing units has not kept pace with demand. However, interest rate increases, as well as macroprudential and other housing policy measures, are expected to weigh on growth in residential investment, since some prospective homebuyers may take on smaller mortgages or delay purchases.”

With higher interest rates, debt-service costs will rise, thus dampening consumption growth, particularly of durable goods, which have been a significant driver of spending in recent quarters. “Elevated levels of household debt are likely to amplify the impact of higher interest rates on consumption, since increased debt-service costs are more likely to constrain some borrowers, forcing them to moderate their expenditures.”

While global oil price benchmarks have risen in the past quarter or so, Canadian oil prices have been flat. Transportation constraints facing Canadian oil producers have held down the price of Western Canada Select oil, leaving it just below October levels. Canadian oil producers have trouble getting oil to the U.S. market, and with no East-West pipelines, they cannot export oil to markets outside of the U.S. This has been a long-standing negative for the Canadian economy.
Markets have been expecting three rate hikes this year, taking the overnight rate to 1.75% by yearend. This level is considerably below the Bank of Canada’s estimate of the so-called neutral overnight rate, which is defined as “the rate consistent with output at its potential level (approximately 1.6%) and inflation equal to the 2.0% target.” For Canada, the neutral benchmark policy rate is estimated to be between 2 .5% and 3 .5%. The need for continued monetary accommodation at full capacity suggests policymakers aren’t anticipating a return to neutral anytime soon.

The Bank’s revised forecasts for inflation and real GDP growth are in the following table. The numbers in parentheses are from the projection in the October Monetary Policy Report. Today’s MPR forecasts that inflation will edge upward while economic growth slows from the rapid 2017 pace (3.0%) to levels more consistent with long-term potential (1.7% to 1.8%).

The Bank of Canada’s future actions will continue to be data dependent. The next policy announcement is on March 7.

Since September, the country added 193,400 jobs, the largest three-month gain since current records began in 1976. Canadian bond yields and the currency rose sharply in the wake of these data. The loonie surged to over 80.50 cents U.S. According to Bloomberg News, the odds of a rate hike at the Bank of Canada’s next meeting on January 17 soared to 70%, from 40% yesterday, based on trading in the swaps market.

The largest employment gains in December were in Quebec and Alberta. In December, 25,000 more people were employed in finance, insurance, real estate, and rental and leasing, following three months of little change. For the year as a whole, jobs increased by 3.5% in the goods-producing sector and by 2.0% in the services-producing sector.

Actual hours worked in December were 3.1% above year-ago levels, the fastest since 2010. As well, new data show that wages are finally accelerating having been stagnant for much of 2017. Wage gains for permanent employees accelerated to 2.9% year-over-year from 2.7% last month–another closely watched indicator for the Bank of Canada.

Also released this morning were December nonfarm payrolls data for the United States. American employers added 148,000 jobs last month as the nation’s unemployment rate remained stable at 4.1%. December’s reported increase was less than the 190,000 expectation. Labour markets are at or very near to full capacity given the persistence of a meagre unemployment rate, which is likely limiting employment gains. December marked the 87th consecutive month of job growth, the longest streak on record and clearly in line with expectations that the Federal Reserve will continue to hike interest rates this year.

Immigration remains a significant driver of housing activity in Canada. Canada has the most robust population growth in the G7, three-quarters of which is attributable to immigration and foreigners moving to Canada will be of growing importance in the future. But the report showed that non-residents – defined as both foreigners and Canadians whose principal residences are outside of Canada, irrespective of citizenship – are not the primary cause of the housing affordability problem in Canada’s two largest cities.

Many have blamed foreigners– mainly the Chinese–for the sky-high prices that have surged in the past three years–pricing many Millennials out of the housing market. A voter backlash spurred provincial governments to introduce a 15% tax on non-resident buyers in Vancouver (August 2016) and Toronto (April 2017), though earlier available data showed that foreign purchases were only between 5 and 10 percent of all home sales. In both regions, the tax slowed housing activity mainly by changing psychology. New listings surged, and buyers became more cautious as their options improved with more supply and lower prices. Other measures to slow housing activity by government and financial institution regulators have led many to assert that “boomers have priced millennials out of the housing market.”

Bottom Line: Non-residents represent a significantly more important factor in the Vancouver region than in the Toronto CMA, as expected. Moreover, non-residents purchase markedly more expensive properties compared to residents in Vancouver than in Toronto.
Wealthy Chinese nationals are a more significant factor in Vancouver than in Toronto, which has been the case for many years–not surprising given the geography. Moreover, many Chinese nationals began buying properties in the Vancouver CMA well in advance of the July 1997 handover of Hong Kong from the United Kingdom to China. Chinese have continued to find the Vancouver region an attractive haven for capital despite the imposition of capital controls in China.
Many are non-residents and have not rented their properties. In consequence, there are relatively more vacant properties in Vancouver than in Toronto. The Vancouver city council approved a tax on empty homes, the first of its kind in Canada, in early 2017, with the first payments due in 2018. Self-reporting owners will be assessed a one percent tax on homes that are not principal residences or aren’t rented for at least six months of the year. Though a similar tax has been discussed by the Toronto city council, to date, it has not had legs.

In a speech this week, Governor Poloz of the Bank of Canada confirmed his continued concern about household indebtedness. Indeed, data released this week by Statistics Canada showed that households continued to pile on debt in the third quarter. The household-debt-to-disposable-income ratio rose by a percentage point to 171.1% last quarter. Relative to assets and net worth, debt also edged higher, but those ratios are much closer to longer run levels, painting a far less dire picture of household finances. And even with households taking on more debt, the share of income needed to service that debt was little changed in Q3, as it has been over the last decade. That will change as the Bank of Canada continues to raise interest rates gradually. However, the prevalence of fixed rate mortgage debt means households won’t feel the increase all at once. Instead, the debt service ratio is likely to rise only gradually. The rising cost of borrowing and more stable home prices should slow credit growth in the year ahead.

But with so much attention paid to the imprudent borrower, I think it is important to reiterate that the vast majority of Canadians responsibly manage their finances. For example, roughly 40% of homeowners are mortgage-free, and one-third of all households are debt-free. Another 25% of households have less than $25,000 in debt, so 58% of Canadian households are nearly debt free. Hence, mortgage delinquency rates are meagre.

The Canadian Real Estate Association (CREA) reported yesterday that home sales jumped 3.9% from October to November–the second most significant increase in two years. Home sales have now risen for the fourth consecutive month, led by a 16% jump in the Greater Toronto Area (GTA), which accounted for two-thirds of the national rise. Even so, sales activity in the GTA was significantly below year-ago levels. Victoria, Ottawa and Regina also recorded strong gains, while Calgary, Edmonton and Montreal posted modest increases.

Not all markets participated in the rally, though. Vancouver was among the few holdouts. Resales fell for a second-straight month by 3.7% in the Vancouver area where affordability strains represent a major issue for buyers.

New Listings Shot Up

Many sellers decided to list their properties ahead of the mortgage rule changes. New listings rose by 3.5% in Canada between October and November. Most of this increase took place in the Toronto area where new listings jumped by a whopping 22.9%. A report released earlier this month by the Toronto Real Estate Board showed that active listings in Toronto rose modestly above their 10-year average in recent months after plunging to historic lows at the start of this year. Pressure has come off Toronto-area buyers as they are now presented with more options. This could soon be the case in Vancouver too. New listings rose sharply in November and, with resales declining in the past couple of months, the sales-to-new listings ratio is finally moving toward more balanced conditions (see charts below).

The number of months of inventory is another important measure of the balance between housing supply and demand. It represents how long it would take to liquidate current inventories at the current rate of sales activity. There were 4.8 months of inventory on a national basis at the end of November 2017 – down slightly from 4.9 months in October and around 5 months recorded over the summer months, and within close reach of the long-term average of 5.2 months. At 2.4 months, the number of months of inventory in the Greater Golden Horseshoe region is up sharply from the all-time low of 0.8 months reached in February and March.

The Aggregate Composite MLS® Home Price Index (HPI) rose by 9.3% y-o-y in November 2017 marking a further deceleration in y-o-y gains that began in the spring and the smallest increase since February 2016. The slowdown in price gains mainly reflects softening price trends in the Greater Golden Horseshoe housing markets tracked by the index, particularly for single-family homes.

Toronto single-family house prices were down 11.6% over the past six months ending November 30 (see chart below). GTA condo prices have fared better, up 0.3% since late May, but the rise is minuscule in comparison to the booming price gains evidenced before the Ontario government’s ‘Fair Housing Plan’ that introduced, among other things, a 15% tax on non-resident foreign purchases of homes.

Price gains have slowed considerably on a y-o-y basis in Greater Toronto, Oakville-Milton and Guelph but remain above year-ago levels (Greater Toronto: +8.4% y-o-y; Oakville-Milton: +3.5% y-o-y; Guelph: +13.4% y-o-y).

Calgary benchmark home prices remained just inside positive territory on a y-o-y basis (+0.3%), while prices in Regina and Saskatoon were down from last November (-3.5% y-o-y and -4.1% y-o-y, respectively).

Benchmark home prices rose 6.7% y-o-y in Ottawa, led by a 7.6% increase in two-storey single-family home prices, by 5.6% in Greater Montreal, driven by an 8.3% increase in prices for townhouse/row units, and by 4.6% in Greater Moncton, led by a 7.8% increase in one-storey single-family home prices. (see table below)

The MLS® Home Price Index provides the best way of gauging price trends because average price trends are prone to be strongly distorted by changes in the mix of sales activity from one month to the next.