Housing Correction Only a Matter of Timing

Canada Economics Weekly 1

CANADA ECONOMICSWEEKLY 19th

May

201

4

Editor: David Madani

Housing correction only a matter of timing While the recent strength of Canada's housing market has been astounding, the regional

breakdown reveals that it has begun to fray at the edges. With house prices already declining in some smaller regions, it may only be a matter of timing before prices in other larger and much more overvalued markets begin to fall more sharply. We still believe that the housing market is overdue for a longer-term correction of as much as 25%.

The housing market slowdown in the regions can't be explained by labour market conditions, which suggests that high house prices and tighter mortgage qualifying rules are making matters worse. With economic conditions likely to remain challenging, we anticipate that some regional housing markets will continue to fray, accompanied by further declines in house prices.

The key data release this week is the consumer price index for April. We estimate that headline inflation rose to 1.9% in April, up from 1.5% in March. Higher gasoline price inflation is partly to blame. Official core inflation, on the other hand, was likely only 1.4%, up from 1.3% in the month before. (See pages 2-3.)

Economic & Market Data (page 4)

Economic Diary & Forecasts (page 5)

Recent Publications (page 6) North America Europe Asia 2 Bloor Street West, Suite 1740 150 Buckingham Palace Road #26-03 Income at Raffles Toronto, ON London 16 Collyer Quay M4W 3E2 SW1W 9TR Singapore, 049318 Canada United Kingdom Tel: +65 6595 5190 Tel: +1 416 413 0428 Tel: +44 (0)20 7823 5000

Managing Director Roger Bootle ([email protected]) Chief North America Economist Paul Ashworth ([email protected]) Canada Economist David Madani ([email protected]) Economist Amna Asaf ([email protected])


Canada's housing market performance over the past year or so has been astounding, with rising prices defying fundamentals such as household incomes and rents. While this fact has convinced some observers that the housing market is healthy, the regional breakdown reveals some troubling twists and turns. In short, Canada's housing market appears to be fraying, surviving for the time being on rapidly rising prices in some of the most overvalued and more thinly traded markets.

At the national level, the balance between existing home sales and the number of newly listed properties for sale suggests that house price inflation will slow in the coming months. (See Chart 1.) On this basis, it does seem as if the housing market is currently enjoying a soft landing.

CHART 1: NATIONAL HOME SALES-TO-LISTINGS & PRICES

Sources Thomson Datastream, CREA

The regional breakdown, however, reveals that Canada's housing market is fraying. In Halifax, for example, housing activity and prices are falling. (See Chart 2.)

CHART 2: HALIFAX HOME SALES-TO-LISTINGS & PRICES

Sources Thomson Datastream, CREA, Capital Economics

Other regional markets such as Winnipeg and Victoria are also experiencing a marked housing slowdown, with prices declining in certain areas. More troubling to the national picture is Montreal's softening market, with prices now at risk of a decline. Despite low interest rates and a stable unemployment rate, it seems clear that the balance of demand and supply is almost as soft as during the recession in 2009. (See Chart 3.)

CHART 3: MONTREAL HOME SALES-TO-LISTINGS & PRICES

Sources Thomson Datastream, QFREB, Capital Economics

The slowdown in regional housing activity and prices isn't a reflection of worsening labour market conditions. Regional unemployment rates have actually nudged lower (see Table 1), albeit partly because of lower labour force participation.

TABLE 1: UNEMPLOYMENT RATE, BY CITIES (%)

City Apr-2014 Oct-2013 May-2013Toronto 7.8 8.1 7.9

Vancouver 5.7 6.6 6.9

Montreal 7.9 8.2 8.2

Calgary 5.3 4.5 4.9

Winnipeg 5.7 5.9 6.3

Victoria 5.1 5.0 5.4

Halifax 6.1 6.4 6.5

Source Statistics Canada

In contrast, house prices in the two largest and most overvalued markets, Toronto and Vancouver, are holding up for the time being, though partly reflecting fewer new property listings. In Toronto, the sales-to-listings ratio suggests that house price inflation will remain close to 5.0% over the next few months. (See Chart 4.)

-8-6-4-20246810121416182022

30

40

50

60

70

80

90

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

MLS Sales-to-Listings Ratio (%, Adv. 7m, LHS)Teranet House Price (%y/y, RHS)

-8-6-4-202468101214161820

30

40

50

60

70

80

90

100

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15


-4-202468101214161820222426

35404550556065707580859095

100105

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15


Housing correction only a matter of timing


CHART 4: TORONTO HOME SALES-TO-LISTINGS & PRICES


In Vancouver, the sales-to-listings ratio suggests that house price inflation will decline materially over the next few months. Should home sales, following the weather-related uptick in April, begin to soften again as we expect, then prices will once again come under downward pressure. (See Chart 5.)

CHART 5: VANCOUVER HOME SALES-TO-LISTINGS & PRICES


Overall, with house prices already declining in some smaller regions, it may only be a matter of timing then before prices in other larger and much more overvalued markets begin to fall more sharply. We still firmly believe that the housing market will ultimately experience a hard landing with prices falling by as much as 25%.

David Madani

The Week Ahead The key data releases this week are March's wholesale and retail sales figures, along with April's consumer price data.

We estimate that retail sales values rose by 0.3% m/m in March, down from a gain of 0.5% m/m.

While sales are getting back to normal after the hit from the bad weather, weakness in both autos and gasoline station sales may have prevented sales to revert back to trend. (See Chart 6.) Preliminary new motor vehicle sales figures suggest that auto sales dropped back a bit in March. Even allowing for a modest rise in vehicle prices, we have pencilled in a fall of 0.5% m/m in motor vehicle sales values. In addition, a fall in gasoline prices may have dampened gasoline stations sales. However, we think that these declines were more than offset by increases in most of the other categories.

CHART 6: RETAIL SALES ($CBN)

Source Thomson Datastream

We estimate that headline inflation rose to 1.9% in April, up from 1.5% in March. (See Chart 7.) Higher gasoline price inflation is partly to blame. Official core inflation, on the other hand, was likely only 1.4%. With the Bank of Canada still focused on the sluggish economy and the corresponding downside risks to the inflation outlook, it will look through any modest uptick in underlying inflation.

CHART 7: CONSUMER PRICE INFLATION (%)

Source Thomson Datastream

Amna Asaf & David Madani

-10-8-6-4-20246810121416182022

30

40

50

60

70

80

90

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15


-15

-10

-5

0

5

10

15

20

25

30

20

30

40

50

60

70

80

90

100

00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15


33

34

35

36

37

38

39

40

41

42

33

34

35

36

37

38

39

40

41

42

2009 2010 2011 2012 2013 2014

Volumes

Values

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

05 06 07 08 09 10 11 12 13 14

Total

Core

Target Range: 1-3%


Latest Data & Main Forecasts

LATEST CANADA ECONOMIC INDICATORS

Monthly Indicators %m/m(%y/y) unless stated Jan Feb Mar Apr

GDP +0.5%(+2.6%) +0.2%(+2.5%) - -

Industrial Production +1.2%(+3.5%) +0.9%(+3.6%) - -

Manufacturing Sales +0.3%(+2.8%) +1.5%(+3.0%) +0.4%(+3.5%) -

Wholesale Sales +0.5%(+2.3%) +1.1%(+3.5%) - -

Retail Sales +0.9%(+4.0%) +0.5%(+3.7%) - -

International Trade (C$bn) Balance -0.3 +0.8 +0.1 -

Exports 40.9 43.3 42.7 -

Imports 41.2 42.4 42.6 -

Housing Starts 176,463 191,633 156,592 194,809

Teranet-National Bank House Prices +0.4%(+4.5%) +0.3%(+5.0%) 0.0%(+4.6%) +0.5%(+4.9%)

Change in Employment +29,400 -7,000 +42,900 -28,900

Unemployment Rate 7.0% 7.0% 6.9% 6.9%

Consumer Prices +0.3%(+1.5%) +0.8%(+1.1%) +0.6%(+1.5%) -

Core Consumer Prices (Bank of Canada) +0.2%(+1.4%) +0.7%(+1.2%) +0.3%(+1.3%) -

Quarterly Indicators %q/q ann.(%y/y) unless stated Q1 2013 Q2 2013 Q3 2013 Q4 2013

GDP +2.9% +2.2% +2.7% +2.9%

Household Consumption +1.0% +3.5% +2.4% +3.1%

Productivity (Business) +1.6% +3.1% +1.0% +3.9%

Current Account (C$bn Ann., as a % of GDP) -58.7(-3.2%) -60.8(-3.3%) -59.2(-3.1%) -64.0(-3.4%)

LATEST MARKET DATA*

Instrument/rate 1 mth ago 1 week ago Latest* Instrument/rate 1 mth ago 1 week ago Latest*

Official Rates Canada 1.00 1.00 1.00 Equity Indices S&P/TSX 14447 14534 14589

US 0-0.25 0-0.25 0-0.25 S&P 500 1862 1878 1871

ECB 0.25 0.25 0.25 Currencies USD/CAD 0.908 0.917 0.919

3mth Rates Dec 2014 1.28 1.27 1.25 CERI** 109.2 110.5 110.7

Dec 2015 1.62 1.59 1.52 Commodities*** Total 671 663 664

Dec 2016 2.22 2.16 2.06 Energy 1809 1769 1763

Gov't Canada 2yr 1.05 1.06 1.04 Excl. Energy 386 388 393

5yr 1.66 1.63 1.53 Nat'l Gas (USD/btu) Henry Hub 4.62 4.57 4.35

10yr 2.39 2.36 2.26 Oil Price (USD/pb) West Texas 103.8 99.9 101.9

Inflation-indexed 15yr 0.42 0.44 0.34 Gold (USD/oz) 1299 1289 1294

Global Yields US 10yr 2.63 2.62 2.51

Euro 10yr 1.49 1.46 1.33

*Latest as at 09.15 EST 16th May 2014. **Bank of Canada Canadian-dollar Effective Exchange Rate Index. ***Bank of Canada Commodity Price Index (BCPI).

MAIN ECONOMIC & MARKET FORECASTS

%q/q ann. (%y/y) unless stated Q3 2013 Q4 2013 Q1 2014 Q2 2014 Q3 2014 Q4 2014 2013 2014 2015

GDP +2.7 +2.9 +2.0 +2.5 +1.0 +1.0 +2.0 +2.0 +1.5

CPI Inflation (+1.1) (+0.9) (+1.4) (+1.7) (+1.8) (+1.9) (+0.9) (+1.7) (+2.0)

Unemployment Rate (%), Period Ave. 7.1 7.0 7.0 7.0 7.0 7.1 7.1 7.0 7.3

Overnight Rate, End Period (%) 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00

10 yr Gov't Canada, End Period (%) 2.54 2.76 2.46 2.60 2.70 2.80 2.76 2.80 3.50

USD/CAD, End Period 0.97 0.94 0.91 0.90 0.90 0.89 0.94 0.89 0.87


Economic Diary & Forecasts

CANADA

Date Country Release/Indicator/Event Time

Previous* Median* CE Forecast* EDT (BST)

Mon 19th CA Victoria Day Holiday - Markets Closed - - - - -

Tue 20th - Capital Economics Annual Conference, Toronto 08.30 (13.30) - - -

CA Wholesale Sales (Mar) 08.30 (13.30) +1.1% +0.4% +0.6%

Wed 21st - Capital Economics Annual Conference, New York 08.30 (13.30) - - -

Thu 22nd - Capital Economics Annual Conference, Boston 08.30 (13.30) - - -

CA Retail Sales (Mar) 08.30 (13.30) +0.5% +0.2% +0.3%

Fri 23rd CA Consumer Prices (Apr) 08.30 (13.30) +0.6%(+1.5%) +0.3%(+2.0%) +0.2%(+1.9%)

CA Core Consumer Prices (Apr) 08.30 (13.30) +0.3%(+1.3%) +0.2%(+1.4%) +0.1%(+1.4%)

*m/m(y/y) unless otherwise stated

KEY FORTHCOMING EVENTS/DATA

Date Event Date Event

29th May Current Account Balance (Q1) 4th Jun Bank of Canada Policy Announcement

30th May GDP (Q1)


Selected Recent Publications

Date Publication Title

Mon 12th Capital Daily What next for EM dollar-denominated government bonds?

UK Housing Market Focus Can the Financial Policy Committee cool the housing market?

Emerging Asia Economics Update Is the Korean won overvalued?

Africa Economics Focus What another five years of ANC rule means for South Africa

Emerging Asia Economics Update Indias next government forced to build on sluggish economy

Middle East Economics Update Saudi Arabian economy looks set to slow from here on

US Housing Market Update Positive signs on home sales and mortgage lending

Latin America Economics Update Argentine economy probably slipped into recession in Q1

Commodities Update Soybean supply set to be more than ample this year

Tue 13th Capital Daily Will India's stock market continue to outperform?

Emerging Europe Update Rise in the Turkish lira belies external vulnerabilities

Emerging Europe Watch Q1 GDP data to show strengthening recovery in Central Europe

China Economics Focus Where is China heading?

US Economics Update Rebound in household debt provides further encouragement

Wed 14th Capital Daily Will the S&P 500 go from strength to strength?

Emerging Asia Economics Update Tight fiscal policy another reason to expect Australian slowdown

Global Markets Update Will India really deliver equity-friendly reforms?

Middle East Economics Update Egypts public finances still dire, but default risk seems limited

Emerging Europe Update Market may be too quick to price in Russia rate cuts

Latin America Economics Update Colombia Election Watch major reforms unlikely (again)

Africa Economics Update South Africa GDP Tracker suggests sharp slowdown in Q1

Canada Data Response Teranet-National Bank House Prices (Apr.)

Japan Economics Update Monetary Indicators Monitor (Apr.)

UK Housing Market Monthly Housing market sending out mixed messages

Thu 15th Capital Daily Treasuries unlikely to be undone by surging term premia

Japan Economics Update How much could higher female employment boost GDP?

Middle East Economics Update Little sign of a turnaround in Saudi consumer spending

Emerging Asia Economics Update Indias wholesale inflation eases, but RBI unlikely to budge

Global Markets Update Do rising term premia pose a threat to US Treasuries?

Emerging Europe Update Central Europes recovery strengthened in Q1

UK Cities & Regions Update Heathrow expansion: becoming more likely, but not a game-changer

Commodities Update Something has got to give in the global steel industry

Emerging Markets Economics Update Which EMs will benefit from Chinas rebalancing?

Canada Data Response Survey of Manufacturing (Mar.)

Global Economics Update Explaining the divergence between the G7 economies

UK Markets Chart Book Inflation Report stems rise in market interest rates

Fri 16th Capital Daily Three compelling reasons for the Bank of Japan to ease further

US Economics Weekly Economic outlook remains positive

European Economics Weekly German engine can't power euro-zone recovery

Canada Economics Weekly Housing correction only a matter of timing

Japan Economics Weekly What to expect from post-tax hike data

Emerging Asia Weekly Is a credit bubble building in the Philippines?

UK Economics Weekly Is the MPC's view on slack still plausible?

For copies of any of these reports, please call +44 (0)20 7823 5000 or e-mail [email protected]

Documents

Housing Correction Only a Matter of Timing