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Canada Not in Recession... Yet

By Dr. Peter Andersen

We advise Canadian home builders and renovators to play it safe. This is not the time to go out on a limb with expansion plans and big financial commitments. The U.S. recession may be more serious than we would like to think. Canada is bound to feel the impact of even a moderate U.S. recession.
The basic problem of collapsing U.S. home prices and mortgage defaults and foreclosures could continue to worsen. Instead of just a two-quarter U.S. recession ending in the summer of 2008, it could return in 2009 after the temporary boost from the 2008 stimulus package ends.
The U.S. economy slipped into a recession at the end of 2007. Employment is declining and consumer confidence has crashed. Companies are trimming both payrolls and capital spending plans. U.S. real GDP will probably show two consecutive declines in the first and second quarters of this year.
This is bad news for Canada's export-dependent economy and for Ontario in particular. Canadian exports were already declining before the U.S. recession began and we can expect much weaker export performance through the spring and summer. The economic indicators for Canada are still generally positive but it would be a mistake to think that Canada's economy, and its housing and renovation sectors, would be immune to the U.S. downturn.
There has been an unprecedented amount of monetary and fiscal stimulus. Under Chairman Bernanke, the Fed has cut interest rates much more aggressively than it ever did under the leadership of Alan Greenspan. Additional rate cuts are expected. In addition, the U.S. Congress responded very quickly with a $150 billion stimulus package, which could get the U.S. economy growing at around a 3.0 per cent rate in the third and fourth quarters of this year.

U.S. Recession Continues
The economic and financial outlook has continued to worsen despite Fed rate cuts. The fiscal stimulus is a one-time effort that will wear off by early 2009. There will have to be some innovative policy moves this year by the U.S. Government, something like another Resolution Trust Corporation, to bail out both mortgaged homeowners and mortgage investors, and  to calm the financial market crisis.
It will be threatened by the possible spread of financial stress from sub-prime mortgages through to consumer debt, bond insurers, commercial real estate loans, corporate debt, hedge funds and private equity debt. The sustainability question will be particularly important for Canada, as we could have enough momentum to sustain growth through to mid-2008 but not enough to last through next year.
Bank of Canada Governor Mark Carney has chosen a particularly difficult time to start his new job. The U.S. economy is in a recession but Canada is not there yet. He was willing to make a 50 basis point interest rate cut on March 4, even though Canada's job market is still tight and wage inflation is at a high level.
Employment increased by 46,000 in Canada in January and the unemployment rate slipped again to a 33-year low of 5.8 per cent. Wage inflation is running around close to 5.0 per cent. Nonetheless, Governor Carney has indicated that he will cut rates further. This must mean that he sees serious threats to Canada's financial system.
Monetary policy easing is good news for mortgage rates, which are coming down. Bank of Canada rate cuts will directly affect six-month and one-year mortgage rates. Variable mortgage rates are coming down as well. The open five-year variable rate is now down to 4.50 per cent on a discounted basis.
The longer-term mortgage rates will move with comparable bond yields. They are moving lower as evidence of a U.S. economic downturn accumulates. The benchmark 10-year Government of Canada bond yield is down by about 70 basis points from last September to a current level of around 3.65 per cent. Canadian banks will be willing to lend to home buyers. This will contrast with the U.S., where the availability of mortgage credit has dried up, even for prime credits.

Starts Forecast to Decline
The resale market is always a good indicator new home market conditions. January resales were below the pace of January 2007, signaling that housing demand is moderating. New listings are up sharply, suggesting that vendors sense a turn in the market and want to sell while conditions are still generally favourable.
House prices give a completely different message in Canada compared to the U.S. The average Canadian new house price edged higher between December and January and stands 6.2 per cent above January of 2007. However, the big run-up in prices seems to be over. 
Forecasts for Canadian starts point to a down year in 2008. Projected declines range from seven to 14 per cent. In recent years, however, forecasts for Canadian housing starts have tended to be too low. The actual numbers consistently exceeded earlier forecasts. Our forecast of 198,000 starts in 2008, at the lower end of the forecasting range, is based on our view that the U.S. recession will have an impact on confidence in Canada.

The overall Canadian economy could avoid the U.S. recession that has just begun. However, Ontario is the most exposed and we expect housing starts there to show another significant decline in 2008. Hopefully we are wrong. However, new home builders should be aware of the risk.

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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