Canada's Housing Bubble

Oct 20 2010 Jeremy Torobin theglobeandmail.com

Canada’s economy just came through the roughest patch since the recession, but still has “underlying momentum,” Bank of Canada Governor Mark Carney says.

The recovery in Canada is in “a very different spot” than that of the United States, Mr. Carney said Wednesday after releasing a report that said the third quarter was weaker than previously expected, and the next four quarters will also lag projections made in July. While acknowledging that the rebound has turned out to be more modest than the central bank anticipated, he urged households and businesses to stick to the long view and position themselves for when conditions in Canada, and around the world, pick up.

For households, that means remembering that today’s interest rates are far from normal and continually assessing whether their debt loads will be manageable once borrowing costs rise. For businesses, it means investing aggressively in machinery and equipment that will help them become more productive and competitive, to mitigate the fact weaker demand around the world and a strong currency could impede Canadian exports for years.

“The underlying momentum in the economy is there,” Mr. Carney later told reporters, adding it would be wrong to obsess about his estimate of 1.6-per-cent growth in the third quarter, the worst showing since the recovery started late last year.

“What we need to focus on, I would suggest, in Canada is the medium term, and getting productivity up, getting investment in place, making sure that household balance sheets are in a sustainable position.”

With many cash-strapped households already spending less as they trim their debt loads, and the U.S. economy too sluggish to put a dent into U.S. unemployment, the central bank said Canada’s economy won’t be operating at full tilt until the end of 2012 and the bank’s preferred gauge of inflation won’t be at its 2-per-cent target until then either.

The economy is expanding at a considerably slower pace than earlier this year, when output was buoyed by billions in government stimulus spending, companies were rebuilding depleted inventories, and newly confident consumers were buying homes and other big-ticket items.

Consumers piled up debt as they took advantage of record-low borrowing costs and rushed to get ahead of federal changes to mortgage rules and the onset of the harmonized sales tax in British Columbia and Ontario. First-quarter growth, for instance, came in at an annual pace of 5.8 per cent.

“People brought purchases forward, in particular in the housing market,” said Benjamin Reitzes, an economist with BMO Nesbitt Burns. “You’re getting the payback for that now.” For the entire year, the economy will grow 3 per cent, the bank said in its outlook, followed by 2.3 per cent in 2011 and 2.6 per cent in 2012. Those figures compare with the bank’s July forecast of 3.5 per cent this year, 2.9 per cent in 2011 and 2.2 per cent in 2012.

The central bank also cut its forecasts for the United States in each of those three years, and for the global economy as a whole in 2011 and 2012.

As a result, export growth will be slower than the central bank had anticipated, making it all the more pressing for companies to do what they can to increase their competitiveness. There is mounting evidence that companies now recognize this and are acting accordingly after business investment was a soft spot earlier in the recovery, Mr. Carney said.

“It is a difficult external environment,” Mr. Carney told reporters. “The renewed emphasis that Canadian businesses are putting on investment, on improving productivity, is absolutely appropriate, and that needs to continue through the next several years.”

As for household debt, the growth of credit taken out by Canadian families has already started to slow, but everyone from borrowers to authorities must “remain vigilant” so people don’t get too overstretched, Mr. Carney said.

“That responsibility starts with the individual; it starts with the household, it extends to the lender, and then ultimately goes to policy makers,” he said.

“We’re still living in relatively abnormal times, with respect to interest rates.” Indeed, Mr. Carney left his benchmark interest rate at a still-very low 1 per cent Tuesday after three consecutive increases.

Economists pointed to language in the quarterly outlook, which said the projections incorporate a gradual increase in borrowing costs, as a reminder that the central banker maintains a tightening bias and will raise rates as quickly as conditions allow.