The economic outlook for Canada’s home builders and renovators has undergone an abrupt change for the worse over the past month. The turmoil in the credit markets may have come to a head in mid-October but confidence has been seriously shaken.
With the stock market having declined so sharply since late September, it is only natural that Canadians hold back on big-ticket purchases like cars, new homes and renovation projects.
2009 Spring Selling Season
Looking ahead to 2009, the spring selling season will be shaped by more than just the recent downturn in the stock market. The effectiveness of the extraordinary policy moves being taken to unlock the international credit freeze and also the extent to which Canada’s economy can ward off the pressures facing the U.S. economy will also play a significant role.
Governments and central banks around the world have responded with breathtaking speed and massive efforts to stabilize the world banking system. The G-7 countries have made an unconditional commitment to apply the full faith and credit of their borrowing ability to backstopping the financial system. That being said, it won’t be any single measure that turns the situation around. A resolution will come about when the combined impact of all the measures taken in concert with one and other reach a critical mass.
With the recession in the U.S. now intensifying there is no doubt that Canada is facing a business cycle downturn. The U.S. economy began to contract in the fall of 2007 and after a temporary boost from the tax rebate stimulus, significant quarterly declines have resumed.
Real GDP in the U.S. is estimated to have declined at about a one per cent annual rate in the third quarter as total consumer spending actually declined and the housing downturn continued. The annualized rate of decline in the fourth quarter is forecast to have intensified to around three per cent. This probably will not be the end of it either. A third consecutive real GDP decline can be expected in the first quarter of 2009. Consumer spending could begin to stabilize but business capital spending and inventories will be a new source of downward pressure. A slow-paced recovery is then expected to begin in the U.S. next spring. Housing construction, meanwhile, is forecast to bottom-out next summer. Economic growth as a whole is then expected to gradually accelerate in the second half of 2009.
How Will Canada Fare?
When your best customer is in trouble, you are bound to feel some side effects. Nonetheless, amidst all the pessimism it is useful to stand back and evaluate some of the factors working in Canada’s favour.
Canada’s economy was resilient through the summer. Real GDP on a monthly basis had not turned down and in August retail sales were actually up by four per cent in price adjusted real terms from the same time one year ago. Total service sector output was also up by 2.4 per cent over this period and the overall economy grew by 1.2 per cent. This is important because, in contrast to the U.S. case, it means this year’s starting point was relatively healthy.
There Is Some Good News
While investors are generally more cautious, there is some good news. Investment spending plans remain solidly positive. Hiring plans are also still positive. Also, the dramatic currency change in recent weeks will benefit Canadian exporters. In particular, this should provide a big boost to the Ontario economy which is Canada’s manufacturing heartland. Real personal income is also holding up reasonably well in Canada and income growth continues to outstrip inflation.
Finally, household finances are stronger in Canada than in the United States. Canadians are not as leveraged as Americans — which is to say total household debt as a percentage of total assets is much lower in Canada. In addition, the credit tap has not run dry in Canada. Canadian banks are tightening credit standards but the flow of credit has never stopped altogether.
Indicators to Watch
There have been a number of bold measures taken to correct the situation and so it’s only natural that everyone is impatient to see results. We expect that they will begin to appear sooner rather than later. In fact, the various measures of credit market stress and risk could reflect a thawing of credit markets as early as this month.
Keep your eye on risk spreads in the financial markets for signs that the corner has been turned. The three-month LIBOR is an obvious choice. Steady yield declines, combined with an edging-up in Treasury Bill rates would be another good sign, as would declines in U.S. mortgage rates. They are far too high at present compared to the banks’ cost of funds. When these credit market indicators start to improve, this will be the first indication that confidence is beginning to return to the financial markets.
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.