Canada's Cautious on Economy

Canadian Finance Minister said he was concerned that economic weakness in the United States, his country's top trading partner, could hold back the domestic economy in the coming months.

He welcomed Monday's stronger-than-expected report on April gross domestic product, which showed Canada's economy had expanded for the first time in three months.

Even so, "one month does not make a trend.

He was concerned about the impact of the U.S. housing crisis on the economy south of the border and believed the property market would not sort itself out until next year.

Despite the headwinds, he believed Canada's economy could continue to grow, though at a slower pace, due to the country's solid fundamentals and a strong labor market.

A rebound in manufacturing helped Canada's economy grow by 0.4 % in April after two months of contraction. The April performance was slightly more robust that market expectations of a 0.3 % increase, and it followed contractions in March and February of 0.2 % and 0.3 %, respectively.

The Canadian economy shrank by an annualized 0.3 %in the first three months of the year, the first quarterly contraction since since April-June 2003.

He was still confident that the government would show a budget surplus this year.

Canada's Housing Boom Over

A year or so ago, selling a house in most of Canada's major markets was not a significant challenge. If you lived in a city with a strong economy, the selling price was heading in one direction only - straight up, usually in double-digit leaps every year.

But the most recent reports suggest the boom times are over.

Prices have already begun falling in Calgary and Edmonton after a couple of years of breakneck growth, and prices for the country as a whole were up just 1.8% year-over-year in May. Between the beginning of January and the end of May, 202,899 homes had been sold nationwide through the multiple listing service (MLS) compared with 233,213 in the same period last year - a drop of 13%.

It as a move towards a more balanced market, but with new listings coming in at a pace more than double the number of houses sold, analysts say it is clear that a slowdown has begun.

The combination of significantly higher listings, reflecting the desire of homeowners to take advantage of the past increase in prices, and weaker demand, due to the past erosion in affordability, are leading to declining sales and softer price performance across the country, but particularly in the west.

It all comes down to a simple matter of supply and demand. On the supply side, past price performance has strongly encouraged additional supply in both the new and existing home markets. Housing starts averaged a strong 234,000 units in the first quarter. While we expect new home construction activity to remain robust, starts should gradually edge down to a lower level of around 200,000 units over the course of the next 18 months.

We had anticipated an increase in new listings as a result of solid price gains in the last couple of years, but the recent surge in new listings has been far greater than anticipated. The jump in supply of homes for sale is assuredly an attempt to take advantage of the past home price appreciation on the part of homeowners and real estate investors.

The Canadian situation is far different than that in the U.S., where the housing market is in full retreat and prices are plummeting in a number of major markets.

It should be stressed that the rise in listings does not reflect homeowners of principal dwellings desperate to sell, and this is the dominant difference between the Canadian and U.S. experience.

In Canada, speculators may be quickly dumping properties on the market to get out while the times are good, but individuals that have a principal dwelling are not under financial duress. This distinction is crucial to evaluating the impact of weaker home price performance on personal wealth and consumption. Canadian consumers are also nowhere nearly as leveraged through their home equity as American consumers are.

There can be no doubt that housing prices are due for a correction in Canada, with the country's economy growing wobbly and prices in several markets peaking after six years of rapid growth.

Nationally the average house price increased less than 2% year-over-year in May. We are getting close to slipping under water. I expect to see negative growth figures at least for the next few months. Housing markets have a lot of inertia. Once they start to move they can go in that direction for several years. The market was flat on its back for most of the 1990s.

Looking ahead, flat sales and prices "may be the best-case scenario, at least for the next year or so. The Canadian economy is anemic and it will probably be like that for the rest of the year.

Canada's housing boom is getting long in the tooth. "It has been with us for six years running. We have already seen prices start to fall in Edmonton and Calgary - cities where the prices rose too rapidly. And they are down in Windsor because of that city's economic slump.

Given that Canada's economy is weakening there is room for prices to decline further. But, there is little chance of a U.S.-style bust in Canada. Our housing market is on a firmer foundation.

Nor does it mean that Canadians should rush to sell their homes. Owning a home generally makes more sense than renting. But as for investment properties, we probably wouldn't recommend it.

Home Listings Flood Housing Market in Canada

A fresh flood of homes on the market sent resale listings to their second consecutive record level in May, while sales activity and price gains both cooled.

There were 54,029 new listings of resale housing units in major markets last month, a 2.2% increase over the seasonally adjusted record hit in April.

On an unadjusted basis, listings rose to 67,628 units, up 7% from May 2007.

Unlike listings, year-over-year sales levels fell in 18 of the 20 markets in the study for which data were available. Information was not available for the Quebec markets because geographical areas in the province are being redefined.

Unit sales across Canada dropped by 17% this May from the year before on an unadjusted basis, and by 0.5% compared with April, 2008, on a seasonally adjusted basis.

Prices edged up 1% in May from the year before to $337,071, a new record for the average price, but the smallest such increase in more than seven years.

Rising food, fuel and home prices are denting consumer confidence. Increasingly cautious home buyers may keep listings on the market longer before being sold, which increases the importance of realistic pricing.

The most dramatic surges in new listings occurred in Saskatoon and Regina, a marked reversal from earlier in the year when they were the country's tightest markets in terms of supply.

New resale listings rose by 58% in Regina and 44% in Saskatoon year-over-year in May. During the same month, year-over-year sales fell in those markets by 28% and 37% respectively.

This pattern has already been seen in other markets including Calgary and Edmonton, where tight supply and soaring prices have given way to a cool-down.

Listings in those markets are now retreating from the peak levels reached in March as the market readjusts, with listings up 1% in Calgary and down 9% in Edmonton from the year before.

It is now becoming increasingly clear that the Canadian housing market is gradually cooling off, with the decline in activity in the West particularly pronounced,. However, we believe that the sector will remain in reasonable shape, and will avoid any U.S.-style housing correction.


Other data included in the report (all figures compare May, 2008 with May, 2007):

– Markets with the largest increases in listings: Regina (+58%), Saskatoon (+44%), Greater Vancouver (+20%), Victoria (+20%), Sudbury, Ont. (+16%), Ottawa (+16%).

– Markets with the largest drops in listings: Edmonton (-9%), Windsor-Essex (-6%), Newfoundland and Labrador (-6%).

– Markets with the largest decreases in sales: Saskatoon (-37%), Edmonton (-35%), Calgary (-33%), Greater Vancouvejavascript:void(0)
Publish Postr (-31%), Regina (-28%).

– Markets with increases in sales (2 of 20): Newfoundland and Labrador (+5.5%), Ottawa (+2.5%).

– Markets with the largest increases in unit price: Regina (+45%), Saskatoon (+29%), Saint John (+22%), Newfoundland and Labrador (+21%).

– Markets with decreases in unit price (3 of 20): Windsor-Essex (-6%), Edmonton (-5%), Calgary (-2%) .

U.S. recession could hurt Canada banks

The possibility of a U.S. recession is the biggest risk for the global financial system, and would have dire consequences for the Canadian economy and domestic banks.

However, the central bank said the threat of a deeper-than-expected U.S. downturn is low and that Canadian financial institutions are well-placed to absorb such a shock even though their increased exposure to U.S. securities has made them more vulnerable.

If the U.S. economy does worsen more than anticipated, Canadian banks would likely see further writedowns, shrinking profits and higher loan loss provisions. This in turn would jack up bank funding costs and lead to tighter credit for consumers and business.

While the probability of such outcomes materializing is relatively low, they nonetheless warrant careful consideration by financial institutions because of the potentially large negative repercussions.

Royal Bank of Canada and Toronto-Dominion Bank both made U.S. acquisitions in the past year that boosted their U.S. banking businesses and added to their portfolios of U.S. consumer and commercial loans. Bank of Montreal also has a Chicago-based U.S. retail banking presence.

It is our belief that we are simply seeing the beginning of credit deterioration in the United States.

Those with retail loan exposure outside of Canada will see steeper increases in provisions for loan losses in the second half of 2008, he predicted. Aiken also expects domestic credit quality to begin to weaken noticeably in 2009, but mainly in the commercial/corporate loan area, not in retail lending.

There is a distinct negative story brewing about provisions for loan losses.

While the Canadian banks are in better financial shape than their U.S. or international rivals, strong earnings growth could remain "elusive" into 2009.

The Bank of Canada also warned that the recent growth in Canada of subprime mortgages and mortgages with no down payment or longer amortizations has left a segment of the population more vulnerable to a worsening economy.

Still, subprime mortgages account for less than 5 percent of all housing mortgages, compared with 14 percent in the United States and is considered to be of better quality.

A sharp housing market correction, similar to that in the United States, is unlikely in Canada.

Policymakers at the bank are closely monitoring the mortgage market but have not yet seen any indication that banks have been hurt by the collapse of the market for some of the more opaque, structured products that have been in trouble during the credit crisis.

The financial market turmoil -- with its associated weakening effect on securitization activity and market-based finance -- has not yet had a noticeable adverse impact on the overall growth of credit in Canada.

The rise in household debt has outpaced that of income and the proportion of debt owed by "vulnerable households" rose to 6.5% in 2007 from 6.2% in 2006.

At present, however, the financial situation of households does not pose a threat to the stability of the Canadian financial system.