Tuesday, January 02, 2007

Housing Market Predictions for 2007

Daring prediction: Interest rates will rise. While the headline focus is on central bank administered rates and how they have increased, longer-term rates are probably more important — and those rates are too low. Low interest rates continue to contribute to rapid inflation of asset values, which, through expanding wealth effects, is starting to get transmitted into overall price inflation. To alleviate this, interest rates must rise enough to reverse some of that asset inflation and dampen wealth effects.

Biggest fear:
Further expansion of excessive wealth effects would increase future inflation and require a later, more painful process of disinflation. The evolving slowdown in the U.S. housing market is just a small part of a frothy global picture.

Biggest hope: That a one-half percentage point increase in mid-term and long-term interest rates can generate a soft landing in asset markets.

Best call: Interest rates would not increase by very much more during the year, and the five-year mortgage rate would average 6.55 per cent during the second half of 2006 — just slightly below where it stands right now. A year ago, I was predicting that five-year rates would, however, rise by half a point during the first half of 2007 — and I continue to expect this.

Worst call:
That the Toronto condominium market would enter a serious correction in the second half of 2006, as a result of a prior excess of investment buying. Instead, new condo sales may well match the 2005 record.

Biggest surprise:
The continued strength of the industrialized economies (including Canada) in the face of increased energy costs. In Canada, the percentage of adults who have jobs has been sustained at a record level. I see this as the consequence of interest rates that are still too low.


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