Canada's Housing Bubble

Warren Jestin

Sep 21, 2010 Warren Jestin Scotiabank chief economist dcnonl.com

The initial spurt of economic revival around the turn of the year has shown signs of sputtering in recent months. The U.S. housing market weakened over the summer, job creation has faltered and sovereign debt problems have forced fiscal retrenchment in parts of Europe.

Chinese growth also has moderated, though activity remains in the fast lane.

Rather than foreshadowing the dreaded ‘double dip,’ these economic results are a reminder that the road to recovery remains a long and winding one. With inventory rebuilding running its course and massive fiscal stimulus losing momentum, global growth will likely decelerate in 2011.

Canada is well positioned to outperform the U.S. and most other major industrial nations, but this will not be a hard race to win.

Output growth will do well to reach 2.5 per cent next year in Canada and will likely be closer to 2 per cent in the U.S. – a significant moderation from 2010 for both countries but still well ahead of the subdued trends expected in the euro zone and Japan.

For China, ‘slower’ growth translates into an output gain in the single-digit range, probably around 9 per cent.

Canada more resilient

The pathways from recession to recovery have been quite different in Canada and the United States.

Domestic economic conditions have been much more resilient here than in the U.S., in large part because of the world-class strength of our financial sector and relatively better household, corporate and government balance sheets.

Canada has recouped roughly two-thirds of the private sector jobs lost during the recession while the U.S. has regained less than one in 10.

Housing prices in many Canadian cities are near record levels at a time when average prices in major U.S. markets are still off by about 25 per cent.

Even with a moderation in job gains and some consolidation in Canada’s housing market in the months ahead, consumer demand should stay stronger on this side of the border.

The Canadian recession was centred in exports, which nose-dived with the plunge in U.S. demand and commodity prices.

The rise in the loonie towards parity against the U.S. dollar further dampened both sales and earnings.

While the global revival has partially reversed this deterioration, overall export revenues are still only three quarters of the levels reached during the height of the commodity boom in mid 2008.

Buoyant consumer spending

The juxtaposition of relatively buoyant consumer spending on this side of the border with weak U.S. household demand has been an important factor behind the escalation of Canada’s trade deficit in motor vehicles and parts.

Low inflation, high unemployment and depressed domestic demand are expected to keep the Federal Reserve on the sidelines and U.S. interest rates exceptionally low for much of the next year.

Relatively stronger conditions here have already caused the Bank of Canada to begin easing up on the monetary accelerator, with interest rates likely to rise by another half percentage point or more by next summer.

While exchange rates are bound to show considerable volatility, the loonie should remain near parity with the U.S. dollar – supported by relatively buoyant commodity prices, Canada’s significantly better fiscal performance and growing international interest in Canadian investments.

Warren Jestin is senior vice-president and chief economist with Scotiabank Group.