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Pace slows but remains respectable
By Dr. Peter Andersen

Canada's economy has slowed but it is still advancing at a respectable pace. Net exports are a drag on activity and automotive and industrial product exports are slumping. However, domestic markets (retail, wholesale and housing) remain strong. Real GDP growth will be around 2.5 per cent through the first half of this year, up from 1.7 per cent late last year. The economy is operating slightly below its full production capacity.

Consumers and businesses confident
Consumer confidence is flat to down slightly but still remains upbeat, according to recent surveys. Big-ticket buying plans remain high and home buying intentions are still strong. There are mixed signals for business confidence though. On the positive side of the coin, companies report that they expect continuing strength in domestic sales and the ones that export indicate that their currency-related concerns have eased somewhat. Intentions to spend on machinery and equipment remain upbeat - in line with last year's positive results.

"The unexpected weakness in housing starts in early 2005 is centered in the single-detached category."

Stable Interest Rates
Private sector hiring declines
The problem is that this does not fit what is actually happening in the job markets. There has been persistent weakness in private sector payroll employment, which is being masked by gains in public sector jobs and self-employment. Private sector employment is now actually lower than it was last fall. Nonetheless, earlier gains still mean that employment is running at a reasonably elevated level.
This will be an important indicator to watch. If the recent pattern of weak private sector job growth continues, this could cut into home buying and renovation plans later this year. Employment growth has always been a good indicator for future directions in consumer confidence.

Building permits shaky
Building permits are a leading indicator for housing starts. There has been volatility in building permits recently but the trend is giving a warning sign. Residential permits were down sharply in March and the seasonally adjusted first-quarter monthly average is below the previous quarter. On a year-to-date basis, though, the total value of single-family permits issued in the first three months of 2005 is still substantially higher (+8.0 per cent) than in the same period in 2004. The March decline mainly reflects weakness in Ontario and Quebec.

Inflation under control
The surge in energy costs has not spilled over into general inflation either in Canada or the United States. The core measure of consumer price inflation, which shows the underlying trend, is running at 1.8 per cent. This is comfortably below the Bank's 2.0 per cent target.
Wage inflation remains low with increases in average hourly earnings in the 2.25 per cent to 3.25 per cent range since last summer. The proportion of firms reporting labour shortages, or difficulties in meeting an unanticipated increase in demand, is also lower than average.
The Bank of Canada is predicting a core rate of CPI inflation of around 1.7 per cent through the rest of 2005. This is good news for Canada's new home builders and renovators as it points to a low and stable interest rate environment.

Favourable credit conditions
In the U.S., the benchmark yield on the 10-year U.S. Treasury note has edged lower again and is currently yielding only around 4.20 per cent. This is having an important restraining effect on Canadian bond yields and, therefore, on longer-term Canadian mortgage rates.
There was a small increase in mortgage rates in March but this was reversed in April. Quoted rates for a one-year closed mortgage are currently around 4.90 per cent and, for a five-year mortgage, around 6.05 per cent. This means that, after discounting, one-year mortgages are available for around 4.15 per cent, and five-year mortgages for around 5.00 per cent.
For those daring enough to consider a convertible mortgage, the effective rate would be 3.75 per cent. The message is that interest rates are still remarkably low and highly supportive for housing demand. This is a key reason we expect stable housing starts in the second and third quarters.

Detached starts a problem
The unexpected weakness in housing starts in early 2005 is centered in the single-detached category. On a year-to-date basis, single starts in urban areas are down by 10 per cent year-to-year in the January-April period. Multiple unit starts are also down year-to-date, but only by one per cent.
The weakness in single-detached starts is not evenly spread out across Canada. The Prairies actually show gains. Manitoba, Saskatchewan and Alberta all show increases in single-detached starts. The Prairie region shows an overall year-to-date single-start increase of nine per cent. The weakness is concentrated in British Columbia, Ontario, Quebec and the Atlantic Region, which all show double-digit percentage declines in single starts: 17 per cent, 15 per cent, 15 per cent and 10 per cent, respectively.

Fundamentals remain positive
There is an increasing concern in Canada about an impending downturn in residential construction. Single-detached starts have been surprisingly weak. The big drop in Ontario is something to worry about. However, supply constraints may be partly responsible. Municipalities are reported to be slow in processing applications. Environmental and sewer/water servicing issues are also supply constraints.
At this point we are not going to lower our 2005 national forecast of 215,000 starts as the fundamentals for housing demand remain positive. Consumer confidence is holding at a high level and mortgage rates remain very low. The "soft patch" that the U.S. economy is going through will keep longer-term interest rates low and stable on both sides of the border. Also, renovation activity continues to show outstanding growth. Retail sales at building and outdoor home supplies stores showed more strength than any other retail sector in February with a year-to-year gain of 12.5 per cent.
. HB

Peter Andersen, a CHBA economist, is president of Andersen Economic Research Ltd. of Toronto. The firm specializes in economic research and forecasting for the Canadian home building industry.

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