The housing downturn that’s taking root across Canada will act as a headwind to economic growth this year, following a period in which real estate powered the economic recovery from COVID-19, but was also characterized by fervent speculation and worsening affordability amid ultralow interest rates.
Nationwide home sales fell 12.6 per cent in April from March, with even steeper pullbacks seen in the frothy markets of Toronto and Vancouver. The national home price index, which adjusts for volatility, fell just 0.6 per cent last month, although price drops were larger in some parts of Southern Ontario.
Rising interest rates have put a quick chill on a feverish rally. Given that more rate hikes are on the way, many economists say Canada could be in the early stages of a protracted housing slump, albeit one welcomed by would-be buyers who got priced out.
For an economy that increasingly relies on housing, the downturn will likely weigh on economic growth in the near future – not only through direct channels, such as reduced real estate commissions, but in indirect ways, such as weaker spending from households that gorged on mortgages and now face higher debt-servicing costs.
“Unfortunately for Canada, we’re in a pretty perilous situation now where our housing activity measures are extremely stretched. … The pandemic basically put what was already stretched on steroids,” said David Doyle, head of economics at Macquarie Group.
As home sales drop and interest rates head higher, “that does create significant downside risks for Canada’s economy,” he added.
Already the largest industry in Canada, real estate became an even bigger chunk of the economy during the pandemic, largely due to record-low mortgage rates that encouraged rabid buying.
Residential investment, as a share of nominal gross domestic product, soared to about 10 per cent at peak times over the past two years, amounting to more than $240-billion in 2021. That’s up from about 7 per cent of GDP before the pandemic – or double the equivalent rate in the United States. For housing bears, it’s a sign that Canadians have become far too infatuated with real estate, and that the country’s economic fortunes are too tied up with those of the sector.
Total residential investment is comprised of three items: new construction, renovations and ownership transfer costs, which include fees to realtors, land transfer taxes and other transaction costs.
This final aspect of investment is most directly exposed to a slump. Mr. Doyle said the April sales drop, if followed by flatter activity in May and June, could curb GDP growth in the second quarter by as much as 1.5 percentage points, on an annualized basis. If sales continue to drop, the drag would be larger.
And that’s before accounting for the potential knock-on effects of weaker home-buying activity, such as fewer renovations and purchases of household appliances.
In its latest forecast, the Bank of Canada estimated the economy would grow by 6 per cent in the second quarter on an annualized basis. “That feels like a stretch to me,” Mr. Doyle said.
Home construction is an aspect of GDP that could hold up well. The federal government wants to double the pace of home building over the next decade, and other levels of government say they also want to add supply. However, Bank of Montreal senior economist Robert Kavcic doubts construction can get much bigger. He pointed to already strong housing starts and a shortage of available workers.
“Physically, there’s no way we can actually double the rate of home construction from what is already the maximum amount of home construction that we can do in this country,” he said.
That said, Mr. Kavcic doesn’t see residential investment, as a percentage of the economy, heading back to the tepid levels of the 1990s. The fundamentals for housing demand are still strong, he said, in part because Canada is targeting a record intake of permanent residents in the coming years.
“I think the issue here is that through 2021, monetary policy was just too easy for too long,” he said. “So, the asset price just ran ahead of what was fundamentally justified.”
The Bank of Canada has raised its policy rate twice this year, taking it to 1 per cent from a pandemic low of 0.25 per cent. Bank officials have said they intend to raise the benchmark rate into a “neutral” range – which neither stimulates the economy nor inhibits it – of 2 per cent to 3 per cent in fairly short order.
The central bank has warned the Canadian economy is likely more sensitive to rising borrowing costs than it used to be. After taking on loads of new mortgage debt over the past two years, the average household now owes a record $1.86 for every dollar of disposable income. During the pandemic, investors have plowed into the housing market, and a growing share of borrowers have steep loan-to-income ratios.
Ultimately, the concern is that debt-addled households will be forced to tighten their belts and drastically reduce their spending.
“Rising interest rates are designed to slow the economy by making borrowing more expensive. That tends to slow sectors like housing,” said Toni Gravelle, a deputy governor at the Bank of Canada, in a speech last week.
“But this slowing might be amplified this time around because highly indebted households will face high debt-servicing costs and will likely reduce household spending more than they would have otherwise. Our base-case scenario includes a slowdown in housing activity. But we could see a larger-than-expected slowdown due to higher indebtedness and unsustainably high housing prices.”
How those financially stretched households react to higher interest rates could force the Bank of Canada to “pause” its rate-hike cycle, Mr. Gravelle noted.
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Yellen Says She’s ‘Very Optimistic’ on Economy But Wary of Rates
(Bloomberg) — Treasury Secretary Janet Yellen said a surprisingly resilient US economy has prompted investors to question what it will take to bring inflation down, but she cast doubt on whether that would force interest rates to stay elevated for a long period.
“People are trying to figure out exactly what it’s going to take to keep inflation moving down,” Yellen said Tuesday in a moderated discussion at the Fortune CEO Initiative conference in Washington. “And the economic resilience that they see maybe suggest higher for longer, but we’ll see. I think it’s by no means a given.”
Yellen also said that it’s possible that higher rates of investment spending — such as on the green-energy transition — could imply higher interest rates over the longer haul. At the same time, the structural forces that held rates down in recent decades — such as demographic trends — remain “alive and well.”
“The answer is, I don’t know,” whether bond yields will stay high over the longer run, Yellen said. “It’s a great question and it’s one that’s very much on my and the administration’s minds.”
Yellen also said that it’s critical to maintain a “sustainable fiscal policy.” She said the current level of debt is manageable — as measured by how much the US spends each year to finance the federal debt as a share of gross domestic product, and adjusted for inflation. But she also indicated that higher long-term rates could pose a threat.
“The forecast we’ve made assumes that interest rates will rise toward more normal levels, but we are seeing a pretty significant increase in nominal” rates, she said.
Yellen also said that she’s “very optimistic” about the outlook for the US economy.
“Consumer spending remains strong, investment spending is solid” and the housing market has stabilized and “seems to be moving up,” she said. “Short term inflation is coming down in the context of an extremely strong labor market,” she also said.
Yellen’s comments come just a couple of days after a last-minute deal was struck to avoid a government shutdown, something the Treasury chief had warned could threaten the economic outlook.
She said that, now, “it’s urgent that Congress allocate funds for Ukraine — that hasn’t been done. That’s really our focus.”
Yellen declined to comment on the battle for House Speaker Kevin McCarthy to retain his post.
(Updates with further comments on interest rates, starting in headline.)
Euro zone economy likely contracted in third quarter amid waning demand, survey suggests
Eurozone business activity remained in contraction at the end of the third quarter of the year as an increased rate of loss of orders led to a further decline in activity. The overall reduction in output was again led by manufacturing, but the service sector saw activity decrease for the second month running.
Input costs continued to rise sharply, and the rate of inflation even picked up from that seen in August, in part due to higher oil prices. Output prices, however, increased at the softest pace in over two-and-a-half years amid muted pricing power.
Forward-looking indicators suggest the economic contraction is likely to persist into the fourth quarter. Future business expectations fell sharply and are now running weak by historical standards to hint at an acceleration in the rate of decline in the months ahead. Similarly, new order inflows are falling at a faster rate than output in both manufacturing and services, suggesting companies will seek to reduce capacity in the months ahead. Likewise, backlogs of work are falling at an accelerating rate to hint at production cuts across goods and services in the months ahead. In the goods-producing sector, inventory reduction remains widespread, suggesting no immediate relief to the intense destocking cycle that has exacerbated the recent downturn in customer demand.
However, as well as subduing output growth as we head into 2024, these factors should also play a role in diminishing pricing power and inflationary pressures, both in manufacturing and services.
Output fall gathers pace
The HCOB Eurozone Composite PMI Output Index, compiled by S&P Global, recorded 47.1 in September according to the flash estimate, up marginally from 46.7 in August but still signalling a solid monthly decline in business activity. Output has now fallen for four consecutive months.
The August reading is indicative of GDP falling at a quarterly rate of 0.4%, but combined with the August and July readings means GDP likely contracted by 0.3% over the third quarter as a whole.
For the second successive month, output falls were seen in both manufacturing and services. That said, the rate of contraction in services eased slightly from August and was still much softer than that seen in manufacturing. The reduction in manufacturing production was unchanged from the rapid pace seen in August. Barring a brief period of growth during the opening quarter of the year, euro area manufacturing output has decreased continuously since the middle of 2022 with recent declines being the steepest recorded since the global financial crisis.
Central to the latest reduction in business activity was a further deterioration in demand, as highlighted by a fourth successive monthly decrease in new orders. Moreover, the fall in September was the most pronounced since November 2020 and – baring pandemic months – the steepest since September 2012.
Manufacturing new orders contracted rapidly again, but the acceleration in the overall rate of decline was centred on the service sector, where the drop in new business was the sharpest since the pandemic. In fact, excluding months affected by COVID-19 restrictions, the fall in services new orders was the largest since May 2013.
The data therefore continue to signal a marked cooling of the demand revival seen in the spring for consumer-oriented services such as travel and tourism, which had boomed in early 2023 amid loosened COVID-19 containment measures compared to the prior three years. Note also that new orders continued to fall at a sharper rate than output is currently being reduced, which – in the absence of a sudden revival of demand – suggests firms will come under pressure to reducing operating capacity in the months ahead.
Job market remains largely stalled
Sharp falls in new orders meant that companies often turned to work on outstanding business in order to maintain activity levels. As such, backlogs of work decreased markedly again during September, with the latest depletion the most pronounced since June 2020. Barring pandemic months, the decline was the steepest since 2012, reflecting the steepest fall in services backlogs since 2012 and the largest falling manufacturing backlogs since the global financial crisis.
Eurozone businesses also signalled a waning of confidence in the year-ahead outlook at the end of the third quarter. Future sentiment dipped sharply to the lowest since November last year. Optimism waned across both monitored sectors, with manufacturing sentiment only just in positive territory.
The combination of spare capacity and reduced confidence in the outlook meant that companies were again cautious in their approach to hiring. Although employment rose marginally in September, the rate of job creation was the joint-second slowest in the current 32-month run of growth.
A fourth successive monthly reduction in manufacturing workforce numbers compared with a slight increase in services employment.
As well as scaling back staffing levels, manufacturers in the eurozone also cut their purchasing activity sharply and reduced their holdings of both purchases and finished goods. The fall in stocks of finished goods was the sharpest in two years.
Reduced demand for inputs meant that suppliers were able to speed up deliveries, with vendor lead times shortening for the eighth consecutive month. The rate at which deliveries quickened was marked, albeit the least pronounced since February.
Pricing power falls
There were differing trends in terms of inflation in September as a sharper rise in input costs contrasted with a weakened rate of output price inflation.
Input costs increased at the fastest pace in four months, albeit at a pace that remained well below the average seen over the past three years. Inflation was driven by the service sector, where prices were up sharply amid higher wages and rising fuel costs. Manufacturing, on the other hand, posted a seventh successive monthly drop in input costs.
Despite the steeper pace of input cost inflation, a weakening demand environment meant that companies increased their selling prices to a lesser extent than in August. In fact, the latest rise in charges was only modest and the softest since February 2021. Manufacturing output prices fell at a marked and accelerated pace, while services charge inflation eased to a 25-month low.
Measured across both sectors, the overall rate of selling price inflation has now fallen to a level consistent with consumer prices rising at a rate below 3% in early 2024, down from the 5.2% rate seen in August.
Looking at growth across the euro area, the euro area’s two largest economies – Germany and France – were the key drivers of the overall downturn in activity during September. Germany saw output decrease for the third month running and at a solid pace, albeit one that was slightly softer than seen in August. German manufacturing production declined at the fastest rate since the opening wave of the COVID-19 pandemic, while services activity was down marginally.
The contraction in France was more severe than in Germany, with activity decreasing to the largest extent since November 2020. Excluding pandemic affected months, the September contraction in output was the sharpest in over a decade. Rates of decrease quickened across both manufacturing and services.
The rest of theeurozone saw business activity remain broadly stable in September. Although manufacturing output decreased for a sixth month running, the fall was the softest since April. Meanwhile, services activity increased slightly, and to a greater extent than in August.
Access the full press release here.
Chris Williamson, Chief Business Economist, S&P Global Market Intelligence
Tel: +44 207 260 2329
Sub-Saharan Africa Economic Growth to Slow to 2.5% in 2023, World Bank Says
JOHANNESBURG: Sub-Saharan Africa’s economic growth is expected to slow this year, dragged down by slumps in heavyweights South Africa, Nigeria and Angola, the World Bank said on Wednesday.
Regional growth will slow to 2.5% in 2023 from 3.6% last year, the bank said in a report, before rebounding to a projected 3.7% next year and 4.1% in 2025.
In per capita terms, the region has not recorded positive growth since 2015, as African countries’ economic activity has failed to keep pace with their rapid increase in population.
Some 12 million Africans are entering the labour market each year, the World Bank wrote in its twice-yearly “Africa’s Pulse” report. But current growth patterns generate just 3 million jobs in the formal sector.
“The region’s poorest and most vulnerable people continue to bear the economic brunt of this slowdown, as weak growth translates into slow poverty reduction and poor job growth,” Andrew Dabalen, the bank’s chief economist for Africa, said.
More than half of the region’s countries – 28 out of 48 – have seen their 2023 growth forecasts revised downward from the World Bank’s April estimates.
The continent’s most developed economy, South Africa, which is facing its worst energy crisis on record, is expected to grow just 0.5% this year.
Economic growth in top oil producers Nigeria and Angola is expected to slow to 2.9% and 1.3% respectively.
Sudan, which is in the midst of a major internal armed conflict that has destroyed infrastructure and brought the economy to a standstill, is expected to be hit by a 12% contraction, the Bank said.
Excluding Sudan, regional growth would be 3.1%.
“The region is projected to contract at an annual average rate per capita of 0.1% over 2015-2025, thus marking a lost decade of growth in the aftermath of the 2014-15 plunge in commodity prices,” the report stated.
While sub-Saharan inflation is expected to ease to 7.3% this year from 9.3% in 2022, it remains above central bank targets in most countries.
Meanwhile, recent military coups in Niger and Gabon in the wake of army takeovers in Guinea, Mali and Burkina Faso, as well as armed conflicts in Democratic Republic of Congo, Ethiopia, Somalia and Sudan, have created additional risk in Africa.
And mounting debt is draining resources, with 31% of regional revenues going to interest and loan payments in 2022.
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