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[Bank of Canada] On Rates and the Canadian Housing Market

by Yvonne von Jena | July 13, 2017


With the first increase in interest rates in seven years, the Bank of Canada has confirmed that a near-decade-long era of low interest rates has ended. The Bank’s Monetary Policy Report provides insights into the Bank’s rationale for raising rates along with its analysis and views on the Canadian housing market.

Interest Rate Increases

The Bank raised its overnight lending rate by a quarter-percentage-point to 0.75% from 0.5%. It:

  • Cited bolstered confidence in its outlook for above-potential growth and the absorption of excess capacity in the economy given recent data
  • Acknowledged recent softness in inflation but judges this to be temporary
  • Recognizes the lag between monetary policy actions and future inflation, and as such the Bank considers it appropriate to raise its overnight rate target at this time

Shortly after the central bank’s announcement, many of Canada’s largest banks matched the move by raising their prime rates by about a quarter-percentage-point to 2.95%. Here is a chart that shows the Bank's rate over the past decade or so: BoC Rate

The Economy in Recent Months

Says the Bank in its July MPR, Canada’s economy has been robust, fuelled by household spending. Growth in GDP in the first quarter of 2017 picked up strongly to 3.7%, which is in line with Bank’s expectations listed in its April MPR. Some of the economic factors noted by the Bank are as follows:

  • Excess capacity in the economy continues to be absorbed
  • An economy that has largely adjusted to the decline in oil prices which began in the second half of 2014
  • Temporarily dampened inflation, driven by factors such as heightened food price competition, electricity rebates in Ontario, and changes in automobile pricing
  • Increased export growth
  • Eased business investment growth; in particular, relative to the first quarter, oil and gas drilling rig activity has levelled off, and the strong growth in imports of machinery and equipment has slowed
  • Abated activity in the housing sector, largely as a result of sharp declines in resales in Toronto and sur­rounding areas
  • All-time highs in motor vehicle sales

The Economy Going Forward

The Bank projects GDP growth at an average 2.5% in the second and third quarters of 2017 and expects that it will remain above potential output growth. Some of the economic factors the Bank notes:

  • GDP growth is expected to broaden further across industries and regions
  • Household spending will continue to support growth, supported by rising employment and wages, but its contribution is anticipated to moderate
  • Consumption growth will be restrained by elevated levels of household debt and higher longer-term borrowing costs as global long-term yields are projected to gradually rise
  • Motor vehicle sales are expected to moderate; sales have been stronger than suggested by fundamental drivers of demand
  • Business investment should also add to growth, a view supported by the most recent Business Outlook Survey

Over the Bank’s longer projection horizon, it expects GDP growth to moderate further from 2.8% in 2017 to 2.0% in 2018 and 1.6% in 2019.

Housing Activity

Until very recently, housing market activity had been quite strong in some regions says the Bank. However, it expects housing activity to ease going forward. In describing the housing market, the Bank notes:

  • Resales: Sharp rise in resales and starts through the early spring in Toronto and surrounding areas
  • Alberta: Markets appeared to have bottomed out in Alberta, with sales up from their levels a year ago
  • National house price: Growth reached 20% on a year-over-year basis in April, led by strong price gains in Toronto and surrounding areas and, to a lesser extent, in the Greater Vancouver Area
  • Price growth in other parts of Canada: Much more subdued
  • Recent moderation in Toronto and area: A recent sharp decline in resales and moderation in starts in Toronto and surrounding areas have contributed to a slowdown in housing market activity since April; the “Ontario Fair Housing Plan has likely played a role, but it is too early to assess the extent of its effect”
  • Higher borrowing costs: Macroprudential and housing policy measures, as well as higher longer-term borrowing costs resulting from the projected gradual rise in global long-term yields, are all expected to weigh on housing expenditures

Looking ahead, the Bank anticipates that residential investment will contribute less to overall growth.

We’re Not Alone

The move to higher rates is not just a Canadian phenomenon. As noted by the Globe, central bankers in the U.S. and Europe are also talking about ending measures put in place to keep credit flowing after the 2008-09 financial crisis. U.S. Federal Reserve Chair Janet Yellen told Congress recently that the U.S. economy is now healthy enough to handle further steady increases in its benchmark interest rate as well as a start to selling its $4 trillion store of commercial bond holdings later this year. The Fed has increased rates recently, is expected to continue doing so over the next few years although interest rates are likely to remain historically low over the longer-term. One of the challenges for our central bank and others around the world is that inflation is still low and falling. Central bankers typically raise rates to keep inflation in check. That is not the problem in Canada, where consumer prices have been rising at well below the Bank’s 2% inflation target. Notes the Globe, this is why Bank of Canada Governor Stephen Poloz said he’s looking beyond current conditions, focusing on where inflation will be a year or two from now. “Reacting only to the latest inflation data would be akin to driving while looking in the rear-view mirror,” he explained to reporters in Ottawa after the rate announcement.

Next?

The next scheduled date for announcing the overnight rate target is September 6, 2017. The next full update of the Bank’s outlook for the economy and inflation, including risks to the projection, will be published in the MPR on October 25, 2017. Many economists are expecting at least one more rate hike this year, most likely in October, when the Bank releases its next quarterly forecast.  


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