Dueling reports from Canadian think tanks, including C. D. Howe and the Canadian Centre for Policy Alternatives, have recently been released on the prospect of a housing crisis in Canada. We have long been concerned about the avid mortgage lending by Canadian banks in H2 2009 and early 2010, which contributed to a housing-led domestic demand revival (see related Critical Issue). Ultra-low interest rates and diminishing lending standards contributed to a deterioration of household debt levels. While Canadian financial institutions did not import some of the worst lending practices of their southern counterparts, they still extended loans with abandon and household indebtedness rose; and the amount of collateral needed to receive a loan was reduced on the margin. We believe that the housing market faces a long period of cooling from 2007-08 and even 2009-early 2010 as housing unaffordability, lower wage gains, the end of tax incentives and lower household formation constrain purchases. We have already seen such slowing in the sales and starts data and we continue to expect declines in these areas.
Private consumption, which has been climbing steadily since the exit from recession last year, slowed markedly in Q2 as several incentives were phased out. The relative strength of Canadian consumers compared to their U.S. and European counterparts should persist, facilitating the continued structural shift in the economy away from manufacturing and exports. Supported by ample credit, household spending was instrumental in pulling Canada’s economy out of recession in 2008-09, expanding at a 4.4% q/q annualized pace in Q1 2010. However, in Q2 we estimate that private consumption slowed to about half the pace registered in Q1. Real retail sales were extremely weak in Q2 and—after falling in April and May—grew only slightly in June, putting Q2 total retail sales at 0.3% q/q annualized compared to hefty growth of 6.6% in Q1. Although conditions could improve from the very soft patch in Q2, cooling retail sales are indicative of a general trend of moderation in personal spending, which will continue in H2 2010 and 2011. A major external (U.S. double dip) or financial market shock would exacerbate such slowing.
Private consumption has been an important driver of Canadian final domestic demand, which has been part of the structural shift in the country’s economy from exports and manufacturing. Supported by ample credit, household spending was also instrumental in pulling Canada’s economy out of recession in 2008-09 and expanding at a 4.4% q/q annualized rate in Q1 2010. However, we expect a moderation in the pace of growth as a number of domestic and global macro factors will constrain Canadian consumers. Primarily, consumption will be tempered by tepid income growth, even as debt levels continue to increase.
On July 1, 2010, two of Canada’s most populous provinces, Ontario and British Columbia, adopted a new value-added tax system, which consolidated federal and provincial sales tax into one – the harmonized sales tax (HST). The new system increases the tax on a range of goods and services, which could exacerbate the cooling of consumption and the housing market, which RGE foresees. Yet, the new tax system will reduce the effective tax rate on new business investment, thus providing an economic boost to the regions via job creation and productivity growth. Given the considerable role of these two provinces in Canada’s overall economic activity, its housing market, and consumption, the impact of the tax harmonization on economic growth will be significant on a national level as well.
Here’s this week’s RGE 360, our Friday morning look at the week ahead in the global economy and our weekly review of the best recent content from Roubini.com.
THE WEEK AHEAD
Sunday, June 20:
- Presidential election takes place in Poland. (See RGE Critical Issue: Polish Politics: Komorowski Still Leading Presidential Race)
- Second round of presidential elections take place in Colombia. (See RGE Critical Issue: Colombia After Uribe: Santos Set to Be Next President)
So the loonie edged back above parity with the dollar today with a lot less fanfare, including from me, than the last time it happened a few years back. Yet this does seem to be a good time to take stock of Canada’s prospects, as we will do in more depth when RGE’s global economic outlook is released later this month. The loonie’s rise seems pretty over-determined, and the currency has been “flirting” with parity for some time.
The province of Alberta, released its revised guidelines for energy sector royalties. The review, which will be followed by implementation guidelines in a few months seems to respond to some of the recent concerns that the province’s new royalty regime, first announced in 2007, remained too stringent and were discouraging investment in the sector, particularly the conventional oil and gas. Natural gas production in Canada has been particularly hard hit of late as ample supply in the U.S. from the development of shale gas, record inventory levels and lower consumer and industrial demand have weighed on North American natural gas prices, reducing the incentives to invest.
It has been quite a few days for Canada – a well hosted (if costly) Olympics with a record number of gold medals including a coveted hockey gold. Now it seems, like the U.S., Canada’s economy bounced back strongly in Q4, growing 5.0% q/q annualized, up from under 1% in Q3 (itself revised up). Net exports again returned to growth (as autos and energy exports picked up and imports fell) and domestic demand climbed by 4.6%. However, as with the U.S. , this return to growth could fade. There are a few warning signs ahead.
Last night I was chatting with BNN about China’s frothy Housing market (See the clip here), which I signaled as one of the risk factors for Chinese growth in 2010 and beyond. Chinese property prices are back up to above pre-recession levels and housing starts are surging. Despite continued demand for housing from the population, the increase in prices means many of the properties changing hands are out of reach for these consumers. Chinese officials have already started to tighten lending standards and we could see more measures into the new year, despite the reliance of local officials for revenues from property sales. See RGE’s recent piece 5Qs for China for 2010 for more on the property market and the health of China’s financial sector.
Today we look at some of the trends that might move global energy markets in 2010. Yesterday’s OPEC meeting, the first hosted by Angola, brought few surprises as countries pledged to maintain their current production cuts in the face of an uncertain global economic recovery. But as growth starts to pick up, could a combination of oil demand growth from emerging market economies and geopolitical supply vulnerabilities boost the oil price back to US$100 per barrel level–a level that could put the economic recovery in jeopardy?