Odds of a Rate Cut Next Week Rise with Disappointed Canadian GDP Growth

The likelihood of a rate cut next week has increased due to disappointing Canadian GDP growth. Real gross domestic product (GDP) only rose by 1.7% (seasonally adjusted annual rate) in the first quarter of this year, which is well below the expected 2.2% and the Bank of Canada’s forecast of 2.8%. Fourth-quarter economic growth was revised to just 0.1% from 1.0%. These figures have led traders to increase their bets on a Bank of Canada rate cut when they meet again next week.

In the first quarter of 2024, higher household spending on services—primarily telecom services, rent, and air transport—was the top contributor to the increase in GDP, while slower inventory accumulation moderated overall growth. Household spending on goods increased modestly, with higher expenditures on new trucks, vans and sport utility vehicles.

On a per capita basis, household final consumption expenditures rose moderately in the first quarter, following three-quarters of declines. Per capita spending on services increased, while per capita spending on goods fell for the 10th consecutive quarter.

Business capital investment rose in the first quarter, driven by increased spending on engineering structures, primarily within the oil and gas sector. Business investment in machinery and equipment also increased, coinciding with increased imports of industrial machinery, equipment and parts.

Resale activity picked up in Q1, driving the rise in housing investment, while new construction was flat. Ontario, British Columbia and Quebec posted the most significant volume increases in resales, while prices in these provinces fell in the first quarter.

New housing construction (+0.1%) was little changed in the first quarter, as work put in place decreased for all dwelling types except double houses. Costs related to new construction, such as taxes and closing fees upon change in ownership, increased in the quarter and were mainly attributable to newly absorbed apartment units in Ontario.

The household savings rate reached 7.0% in the first quarter, the highest rate since the first quarter of 2022, as gains in disposable income outweighed increases in nominal consumption expenditure. Income gains were derived mainly from wages and net investment income.

Investment income grew strongly in the first quarter of 2024 due to widespread gains from interest-bearing instruments and dividends. Higher-income households benefit more from interest rate increases through property income received.

Household property income payments, comprised of mortgage and non-mortgage interest expenses, posted the lowest increases since the first quarter of 2022, when the Bank of Canada’s policy rate increases began.

Bottom Line

This is the last major economic release before the Bank of Canada meets again on June 5. Traders in overnight markets put the odds of a rate cut at next week’s meeting at about 75%, up from 66% the day before. Bonds rallied, and the yield on the Canadian government two-year note fell sharply, reflecting this change in sentiment. 

The Bank of Canada has good reason to cut the overnight policy rate next week. Core inflation measures have decelerated sharply in recent months, and the economy is growing at a much slower pace than the central bank expected. The Bank has been very cautious, and there remains the possibility that they will wait another month before pulling the trigger on rate cuts, but at this point, we see no reason to delay any further.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

Federal Budget Targets Rich Canadians For New Spending

The budget focuses on helping Millennial and Gen Z voters experiencing rising housing costs and other inflationary pressures. The government has set fiscal anchors, such as keeping the deficit below 1% of GDP starting in 2027.

The Canadian federal government released its 2023 budget over a year ago, promising to conduct a strategic spending review to find $15.4 billion in savings. The savings were supposed to achieve fiscal credibility by offsetting the $43 billion in new government spending. However, nearly a year after its announcement, the spending review found only $9 billion in savings, while the government piles on new spending measures in this year’s budget.

The fiscal path is mostly the same as in the 2023 Fall Economic Statement, but only after revenue gains from a resilient economy and further tax increases triggered even bigger spending initiatives.

Government spending is expected to be $480 billion in the next fiscal year, including $54 billion in payments on the country’s debt. 

Finance Minister Freeland also announced a soak-the-rich tax scheme, levelling higher taxes on capital gains for people who make more than $250,000 selling stock or property other than a person’s primary residence.

Currently, 50% of capital gains profits are taxed, compared to 100% of a person’s employment income. That will remain the case for the first $250,000 of capital gains income, but it will rise to 66.6% on income above that level. So, the proposal is to reduce the tax-exempt amount to one-third for capital gains exceeding $250,000.

The lower exemption would also apply to businesses for all capital gains, not just those over $250,000. The additional capital gains taxes are expected to rake $19.4 billion into the government’s coffers over the next five years, which is no small measure. This will reduce business capital spending, already at rock-bottom lows, rendering the Canadian productivity problem even more egregious. Higher capital gains taxes also disincentivize investment in residential rental real estate. 

The FY24/25 budget deficit is estimated at $39.8 billion (1.3% of GDP), with the numbers massaged just enough to meet the various ‘fiscal guideposts’. Any path to a balanced budget continues to be absent. 

Bank of Canada Governor Tiff Macklem has said provincial government spending is already making it harder to lower inflation. Running federal deficits — on top of large provincial deficits in Quebec, Ontario and British Columbia — is irresponsible. The government had previously set fiscal anchors, like keeping the deficit below 1% of GDP starting in 2027.

Philip Cross of the National Post writes, ”deficit spending when inflation is above target violates the 1991 accord between the Government of Canada and the Bank of Canada, which “jointly set forth targets for reducing inflation” and requires both parties to collaborate to achieve that goal.”

Cumulatively, the total deficit between FY23/24 and FY28/29 is now running $10 billion larger than in the Fall Economic Statement.

The Housing Plan

The housing measures were pre-announced, and the market impact should be minimal. However, the higher capital gains inclusion rate will impact those planning to sell valuable properties with much lower cost bases. It will change the economics of real estate investment in rental properties, an area that needs to be more generously funded. 

Some Other Housing Measures:

Allowing 30-year mortgage amortizations for first-time home buyers purchasing new builds. This measure zeroes in on a small subset of the market. In general, though, it stokes excess demand and ultimately does little to improve affordability once prices adjust. Also, limits on the size of insured mortgages mitigate its impact in our most expensive cities. Pre-construction sales usually require a 20% downpayment, which limits the use of insured mortgages, which account for only 15% of mortgage originations.

Increase the RRSP Home Buyers’ Plan limit from $35,000 to $60,000 and extend the three-year payback period.

Create a renters’ bills of rights and tenant protection fund. Some details here are curious, such as a national standard lease agreement (which is provincial jurisdiction). At any rate, the deck is stacked against landlords from bringing more quality rental supply to market—think taxes.

Accelerated capital cost allowances on the construction of new purpose-built rentals and removal of the HST on the construction of student rentals.

Increase the annual Canada Mortgage bond limit to $60 billion from $40 billion.

Top up the Housing Accelerator Fund to incentivize the removal of zoning barriers and tie transit funding to densification along transit corridors.

Bottom Line

This is a pre-election ‘tax and spend’ budget, which will do little to address the problems it claims to solve. It exacerbates other concerns, including insufficient business capital spending, low productivity growth, and insufficient investment in rental real estate. 

Slowing the growth in nonpermanent immigration will, in time, do more to address the housing shortage than any of these measures. 

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

Today’s StatsCanada Labour Force Survey for February was a mixed bag and shows the dramatic effect of surging immigration. Canadian employment rose by a much stronger-than-expected 41,000, dominated by a 71,000 rise in full-time jobs. 

The employment rate–the proportion of the population aged 15 and older who are employed–fell a tick to 61.5%. This is the fifth consecutive monthly decline, the most extended period of consecutive decreases since the six months ending in April 2009 during the global financial crisis. The Bank of Canada has emphasized the importance of the employment rate in recent commentary. 

The employment rate in February 2024 was down 0.9 percentage points from the recent peak of 62.4% observed in February 2023. This downward trend is associated with the unprecedented ballooning of the working-age population.

The unemployment rate increased 0.1 percentage points to 5.8% in February, offsetting the decline in January. The unemployment rate has held relatively steady in recent months, at 5.8% for three of the past four months. This follows an upward trend from April 2023 to November 2023, when the rate increased from 5.1% to 5.8%. The labour force participation rate—the proportion of the population aged 15 and older who were employed or looking for work—held steady at 65.3% in February.

The labour force jumped 76,000 last month and is up more than 550,000 in the past year, while the adult population has surged by more than 1 million people (+3.2%), compared with a job increase of 368,000. Even very strong job growth is not keeping up with the torrid influx of new workers, dampening wage inflation. 

Most of the new jobs were in the service sector, led by employment in accommodation and food services following a decline in the prior month. Also rebounding was employment in professional, scientific, and technical services. On a year-over-year basis, employment in this industry was up 85,000 (+4.6%), the second-largest year-over-year increase among industries, after transportation and warehousing (+104,000; +10.6%).

In February, average hourly wages were up 5.0% year-over-year, following an increase of 5.3% in January. This is still above the Bank of Canada’s comfort zone, although policymakers suggested that wage inflation appeared to have peaked in this week’s policy statement.

Bottom Line

We will see one more Labour Force Survey on April 5th before the Bank of Canada meets again on April 10th. The all-important CPI inflation data will be released on March 19th. 

Today’s report, while strong, suggests that the surge in the working-age population and the decline in job vacancies could continue to temper wage inflation. The Bank of Canada will need more proof before it releases the brakes and lowers interest rates. 

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

Canadian Home Sales Continued Their Upward Trend in January As Prices Fell Modestly

The Canadian Real Estate Association announced today that home sales over the last two months show signs of recovery. National sales were up 3.7% between December 2023 and January 2024, building on the 7.9% gain in December. The chart below shows that despite the two-month rise, sales remain 9% below their ten-year average. According to Shaun Cathcart, CREA’s Senior Economist, “Sales are up, market conditions have tightened quite a bit, and there has been anecdotal evidence of renewed competition among buyers; however, in areas where sales have shot up most over the last two months, prices are still trending lower. Taken together, these trends suggest a market that is starting to turn a corner but is still working through the weakness of the last two years.”

National gains were once again led by the Greater Toronto Area (GTA), Hamilton-Burlington, Montreal, Greater Vancouver and the Fraser Valley, Calgary, and most markets in Ontario’s Greater Golden Horseshoe and cottage country.

The actual (not seasonally adjusted) number of transactions was 22% above January 2023, the most significant year-over-year gain since May 2021. While that sounds like a resounding rise in activity, January 2023 posted the weakest transaction level in nearly twenty years.

There is pent-up demand for housing, and recent buyers are lured back into the market by the recent price decline and the fear that prices could rise significantly once the Bank of Canada starts cutting interest rates. 

New Listings

The number of newly listed homes increased 1.5% month-over-month in January, although it remains close to the lowest level since last June.

“The market has been showing some early signs of life over the last couple of months, probably no surprise given how much pent-up demand is out there,” said Larry Cerqua, Chair of CREA.

With sales up by more than new listings in January, the national sales-to-new listings ratio tightened further to 58.8% compared to under 50% just three months earlier. The long-term average for the national sales-to-new listings ratio is 55%. A sales-to-new listings ratio between 45% and 65% is generally consistent with balanced housing market conditions, with readings above and below this range indicating sellers’ and buyers’ markets, respectively.

There were 3.7 months of inventory on a national basis at the end of January 2024, down from 3.8 months at the end of December and 4.1 months at the end of November. The long-term average is about five months of inventory.

Home Prices

The Aggregate Composite MLS® Home Price Index (HPI) fell by 1.2% month-over-month in January 2024, adding to the 1.1% price decline in December.

Price descents of late have been predominantly in Ontario markets, particularly the Greater Golden Horseshoe and, to a lesser extent, British Columbia. Elsewhere in Canada, prices are mostly holding firm or, in some cases (Alberta and Newfoundland and Labrador), continuing to rise.

The Aggregate Composite MLS® HPI was up 0.4% year-over-year in January 2024, similar to readings over the past six months. 

Bottom Line

Sales in December and January generally run at about half the peak spring season pace. That could be especially true this year, with interest rates likely to begin falling by mid-year. A strong housing rebound is coming. Housing markets have bottomed, buyer sentiment is improving and fixed mortgage rates have started declining.

Housing markets in Toronto, Vancouver and Montreal are relatively balanced again, and with the spring season, we will see a rise in new listings. 

In other news, the inflation data released yesterday in the US were higher than expected, pushing rate-cut forecasts further out. With the strength in the US economy, the 5-year government of Canada bond yield has quietly risen more than 50 basis points this year.

Canada’s Housing Minister, Sean Fraser, said he expects the fall in interest rates this year to encourage builders to ramp up their activity, helping to alleviate some of the country’s crunched housing supply. At a news conference yesterday, the minister said, “My expectation is if we see a dip in interest rates over the course of this year, a lot of the developers that I’ve spoken to will start those projects that are marginal today.”

Sean Fraser, asked whether he’s concerned that Bank of Canada rate cuts will unleash pent-up demand and higher home prices, said lower borrowing costs should also lead to an increase in supply. Fraser said whatever happens with rates, the government’s course of action will remain the same. “We need to do everything we can as quickly as we can to build as many homes as we can. And that’s going to be true today and six months from now, regardless of what may happen in the interest rate environment that we’re dealing with.”

At a news conference last week, Bank of Canada Governor Tiff Macklem said that while he’s heard from developers who’ve indicated higher rates are delaying projects, lowering rates would have a more significant impact on demand.

“It’s very clear in the data that the effects of interest rates on demand are much bigger than those on supply,” he told reporters.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

Today’s StatsCanada Labour Force Survey for December was a mixed bag and far more robust than the weak headline figure suggests. Total employment in Canada barely budged, rising by a mere 100 jobs in the final month of last year. However, the labour force participation rate fell, leaving the unemployment rate at 5.8%. Most economists had been expecting considerably more robust job growth and a rising unemployment rate.

Canada has one of the world’s fastest-growing populations owing to high immigration levels. However, employment growth has been slower than labour force growth in recent months.

The employment rate–the proportion of the working-age population with jobs–trended downward in 2023 among core-aged men and women (aged 25 to 54).

The participation rate—the number of employed and unemployed people as a percentage of the population aged 15 and older—fell in December (-0.2 percentage points) to 65.4%. This was down from a recent peak of 65.7% in June. Most of the decline from June to December was attributable to a drop in the youth participation rate, which decreased 2.1 percentage points to 63.5% over the period. On a year-over-year basis, the labour force participation rate fell 3.3 percentage points to 85.4% among youth not attending school. At the same time, it declined 1.0 percentage points to 46.4% among youth who were students (not seasonally adjusted).

The participation rate held steady among those in the core-aged group (88.7%) and people aged 55 years and older (36.9%), compared with June 2023 and December 2022.

Total hours worked rose 0.4% month-over-month in December and 1.7% from a year earlier. That followed a 0.7% month-over-month drop in November.

Employment in professional, scientific and technical services increased by 46,000 (+2.4%) in December, following little change in the three previous months. This was the second monthly increase in the industry in 2023, the first having been a rise of 52,000 in August. On a year-over-year basis, employment in this industry was up by 78,000 (+4.2%) in December.

Following four months of little change, employment in health care and social assistance rose by 16,000 (+0.6%) in December, building on increases in June (+21,000) and July (+25,000). On a year-over-year basis, health care and social assistance employment increased by 124,000 (+4.8%) in December. According to the most recent data from the Job Vacancy and Wage Survey, the job vacancy rate in healthcare and social assistance was 5.3% in October 2023, down from a peak of 6.3% in April but still the highest rate across all sectors.

In December, employment fell in wholesale and retail trade (-21,000; -0.7%) for a third consecutive month. From August to December, work in the industry decreased by 80,000 (-2.7%). This followed gains from December 2022 to August 2023, when employment increased by 108,000 (+3.7%).

Employment rose in British Columbia (+18,000; +0.6%), Nova Scotia (+6,300; +1.3%), Saskatchewan (+4,800; +0.8%), and Newfoundland and Labrador (+2,400; +1.0%) in December, while it declined in Ontario (-48,000; -0.6%). Employment in other provinces was primarily unchanged.

The most concerning thing for the Bank of Canada was the acceleration in wage inflation to 5.4% y/y last month, compared to 4.8% in the prior two months. With Canadian productivity falling, this is particularly troublesome for the overall inflation outlook. For this reason, the Bank of Canada will continue to be cautious.

Bottom Line

The next Bank of Canada confab is on January 24, before which we will see the December inflation data on January 16. Given the mixed labour force survey, particularly the wage spike, the Bank of Canada will remain cautious. They will wait until inflation is sustained meaningfully before 3% before cutting the overnight policy rate for the first time this cycle.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

Today’s inflation report was stronger than expected, unchanged from October’s 3.1% pace. While some had forecast a sub-3% reading, the November CPI data posted a welcome slowdown in food and shelter prices. Increases in recreation and clothing offset this – both are discretionary purchases. Cellular services and fuel oil prices declined on a year-over-year basis.

The CPI rose 0.1% from October to November, the same growth rate as in October. The steady pace of annual inflation resulted from the base effects in the energy sector. Gasoline prices fell to a lesser extent month over month in November (-3.5%) than in October (-6.4%). Base effects will also inflate next month’s year-over-year data as well.

Core prices aligned with the headline figures, as the Bank of Canada’s favourite core measures came in at roughly 3.5%. Even excluding food and energy, the core rose 3.5% y/y. The core data were more favourable at three-month trends, posting at about 2.5%.

Bottom Line

Today’s CPI data show why Governor Tiff Macklem is cautious about rate cuts, but judging from the past three months, core inflation is on a downward trend. 

In a speech on Friday, Bank of Canada Governor Tiff Macklem said inflation could get “close” to the bank’s 2% target by late next year, though he also said it was “still too early to consider cutting our policy rate.”

The economy is slowing, labour markets have eased, and price pressures are slowing. The road to 2% inflation will be bumpy, but it remains likely that monetary tightening has peaked, and rate cuts will begin by the middle of next year.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

Before we get into the details of the November housing market data released this morning by the Canadian Real Estate Association (CREA), big positive news for housing occurred yesterday. The US Federal Reserve gave its clearest signal yet that its historic policy tightening campaign is over by projecting more aggressive interest-rate cuts in 2024. This ignited one of the biggest post-meeting rallies in bonds and stocks in recent memory. Global shares spiked higher. Short-term Treasuries posted their best day since March, while world currencies surged against the US dollar and corporate bonds rallied. Canadian markets followed suit. If anything, Canada is far more interest-sensitive than the US, and our economy is far weaker.

As the charts below show, monthly mortgage payments relative to after-tax income are far higher in Canada than in the US, even more so given the tax deductibility of mortgage interest and property taxes south of the border. The US economy grew by a whopping 5.2% in the third quarter compared to a decline of 1.1% in Canada.  Therefore, the Bank of Canada will likely cut interest rates sooner and more aggressively than in the US, improving housing affordability.

The CREA data for November showed a bottoming housing market. Home sales recorded over Canadian MLS® Systems edged down by 0.9% from October to November 2023, the smallest decline since July.

New Listings 

Sellers move to the sidelines as well. The number of newly listed homes fell 1.8% month-over-month in November. This followed a 2.2% decline in October.

With new listings down by more than sales in November, the national sales-to-new listings ratio tightened slightly to 49.8% compared to 49.4% in October. It was the first time this measure has increased since April. The long-term average for the national sales-to-new listings ratio is 55.1%.

There were 4.2 months of inventory nationally at the end of November 2023, up only slightly from 4.1 months at the end of October. As such, this measure also looks to be stabilizing and is still almost a full month below its long-term average of nearly five months of inventory.

The second chart below shows that we are definitely in a buyers’ market.

Home Prices

The Aggregate Composite MLS® Home Price Index (HPI) declined by 1.1% month-over-month in November 2023, reflecting softer market conditions since the end of the summer. Prices often react with a slight lag, so it will be interesting to see if month-over-month declines get smaller or stop getting larger in December in response to a stabilizing demand-supply balance.

While price declines remain mainly an Ontario phenomenon, home prices are now softening in the Fraser Valley, Winnipeg, and Halifax. Elsewhere in Canada, prices are mostly holding firm or, in some cases (Alberta, Saskatchewan, New Brunswick, Price Edward Island, Newfoundland and Labrador), continuing to climb. The Aggregate Composite MLS® HPI was up 0.6% on a year-over-year basis. 

Bottom Line

The Bank of Canada policymakers will meet again on January 24th. While it will likely be several months before the Bank begins to cut the policy rate, market-driven interest rates have fallen sharply. Fixed mortgage rates have also come down but more moderately. I expect to start easing monetary policy in the spring, taking the overnight rate down by roughly 100 bps by yearend 2024. Housing activity will strengthen in 2024 and 2025, although the economy will be burdened by a substantial rise in monthly mortgage payments as many renewals or refinancing rise, peaking in 2026. 

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres

It was widely expected that the Bank of Canada would maintain its key policy rate at 5% for the third consecutive time. It will continue to sell government securities (quantitative tightening) to normalize its balance sheet. Market participants weighed and measured each word of the Bank of Canada press release and assessed that the Bank took a less hawkish stance. 

This time, the release said, “Higher interest rates are clearly restraining spending: consumption growth in the last two quarters was close to zero, and business investment has been volatile but essentially flat over the past year. Exports and inventory adjustment subtracted from GDP growth in the third quarter, while government spending and new home construction provided a boost. The labour market continues to ease: job creation has been slower than labour force growth, job vacancies have declined further, and the unemployment rate has risen modestly. Even so, wages are still rising by 4-5%. Overall, these data and indicators for the fourth quarter suggest the economy is no longer in excess demand.”

At the prior meeting in late October, the Bank said that the labour market remained “on the tight side” but acknowledged today that it was loosening. Indeed, the October Monetary Policy Report suggested that the inflation rate would not hit its 2% target level until late 2025.

Today, the tone was much more optimistic, suggesting that policymakers are increasingly confident interest rates are restrictive enough to bring inflation back to the 2% target. Still, Bank officials want to see more progress on core inflation before it begins to ease. It said, “The Bank’s preferred measures of core inflation have been around 3½-4%, with the October data coming in towards the lower end of this range.”

The central bank focuses on “the balance between demand and supply in the economy, inflation expectations, wage growth, and corporate pricing behaviour” and remains resolute in restoring price stability.

Bottom Line

Bond yields peaked in early October and have fallen by nearly 100 basis points. This has led to reductions in fixed mortgage rates; however, those cuts have been far less than historical experience would have suggested, given the rally in 5-year government bonds. 

Cuts in variable mortgage rates await a reduction in the overnight policy rate, which triggers a commensurate decline in the prime rate, which is currently stuck at 7.2%. I expect the Bank of Canada to begin cutting the policy rate by the middle of next year, taking it down a full percentage point to 4% by year end.

Source: Dr. Sherry Cooper, Chief Economist, Dominion Lending Centres