Good News Is Bad News For The Bank Of Canada

The Canadian economy continues to show marked resilience to high-interest rates. Statistics Canada released data this morning showing real GDP rose at an above-consensus 3.1% annual rate in the first quarter of this year. The estimate for April growth was also firm, a harbinger of continued strength in Q2. The combined drags of the public sector strike and the Alberta wildfires didn’t cause a significant downdraft.

First-quarter growth was driven by strong international trade and robust household spending. These factors were partly mitigated by slower inventory accumulation and declines in new housing construction and business investment in machinery and equipment.

After two quarters of minimal growth, household spending rose for goods (+1.5%) and services (+1.3%) in the first quarter of 2023. Expenditures on durable goods (+3.3%) were driven by motor vehicles, including new trucks, vans, and sport utility vehicles (+7.8%). Spending on semi-durables (+4.3%) was led by garments (+4.5%), while spending on non-durable goods (-0.2%) declined slightly.

Service spending picked up in the first quarter of 2023, led by food and non-alcoholic beverage services (+4.4%), and alcoholic beverage services (+6.5%). Meanwhile, travel was on the rise, with expenditures by Canadians abroad up 6.8% in the first quarter, compared with a 3.3% decrease in the previous quarter.

These data do not portend a household sector overly burdened by rising mortgage and credit card payments.

Coinciding with higher borrowing costs and slowing mortgage borrowing, housing investment fell 3.9% in the first quarter of 2023, the fourth consecutive quarterly decrease. The decline in investment was widespread—as new construction (-6.0%), renovations (-2.1%), and ownership transfer costs (-1.5%), which represents resale activity, were all down.

We know housing activity has picked up considerably since the first quarter, undoubtedly adding to Q2 growth. Also expansionary is the persistent rise in employee compensation, led by salary gains in professional and personal services, manufacturing and construction.

One warning sign is the declining household savings rates and slower disposable income. Persistently high interest rates had a predominantly negative effect on net property income, as increases in interest income (+6.4%), mainly from deposits, did not keep pace with higher interest payments on mortgages (+14.7%) and consumer credit (+10.9%).

In contrast with lower disposable income, consumption expenditures (in nominal terms) rose 2.1% in the first quarter of 2023. This was faster than the 1.4% pace recorded in the fourth quarter of 2022, partly due to inflationary pressures. As a result, the household saving rate was 2.9% in the first quarter of 2023, down from 5.8% at the end of 2022. The household saving rate approached the pre-pandemic level, which averaged 2.1% in 2019.

Business incomes fell significantly in Q1, and judging from the stock market, corporate earnings news has also been disappointing across a wide array of sectors in the second quarter.

Bottom Line

The strength in today’s data and the higher-than-expected inflation number for April will cause the Bank of Canada to seriously consider raising the overnight rate by 25 bps to 4.75% when they meet again next week. I think they will hold off to see the May employment and inflation data before they pull the trigger.

Markets have already responded to the numbers. Short-term interest rates remain well above levels posted earlier this year, although that is mainly about the debt-ceiling issue in the U.S. The Bank’s statement will undoubtedly be rather hawkish.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Canadian Inflation Rose More Than Expected in April, But Core Inflation Slowed

There’s been an unexpected hiccup in the Bank of Canada’s ongoing battle against inflation. Year-over-year, price pressures escalated to 4.4% in April, an uptick from the previous month’s 4.3% and significantly exceeding the average economist’s prediction of 4.1%. This marks the first rise in overall inflation from the last June. Ironically, higher interest rates are intended to tackle inflation, but rising rent prices and mortgage interest costs contributed the most to the all-items CPI increase last month.

This sketches an unusual scenario for the Bank of Canada as it approaches its June 7th rate decision. The economy remains resilient, with Canadians grappling with escalated interest rates and continued price pressures. Spring 2023 increasingly looks like the turnaround point for Canada’s housing market after a year-long slump, and labour markets remained firm in April.

To be sure, inflation is down significantly from the 8.1% year-on-year peak experienced last June. The initial reduction in inflation was swift and relatively straightforward, but predictably, the following phase is proving to be considerably more challenging.

The CPI was up 0.7% in April, following a 0.5% gain in March. Gasoline prices (+6.3%) contributed the most to the headline month-over-month movement. Excluding gasoline, the monthly CPI rose 0.5%. On a seasonally adjusted monthly basis, the CPI rose 0.6%.

Gasoline prices rose 6.3% in April compared with March, the most significant monthly increase since October 2022 and contributing the most to the acceleration in the headline CPI. This increase followed an announcement from OPEC+ (countries from the Organization of Petroleum Exporting Countries Plus) to reduce oil output, pushing prices higher. The switch to summer blend and increased carbon levies also boosted prices.
Nevertheless, gas prices were 7.7% lower in April 2023 compared with April 2022, when prices were higher due in part to Russia’s invasion of Ukraine. Compared with 18 months earlier, gasoline prices were 10.0% higher in April 2023.

Shelter costs rose 4.9% year-over-year in April after a 5.4% increase in March. Canadians continued to pay more in mortgage interest cost in April (+28.5%) compared with April 2022, as more mortgages were initiated or renewed at higher interest rates. The higher interest rate environment may also contribute to rising rents in April 2023 (+6.1%) by stimulating higher rental demand.

The year-over-year increase in the homeowners’ replacement cost index slowed for the 12th consecutive month in April (+0.2%) compared with March (+1.7%), reflecting a general cooling of the housing market.

Year over year, prices for groceries rose at a slower rate in April (+9.1%) than in March (+9.7%), with the slowdown stemming from smaller price increases for fresh vegetables and coffee and tea.

Bottom Line

The uptick in April inflation, especially monthly, shows that the road to 2% inflation will be bumpy. Still, the Bank of Canada will be content that their measures of core inflation continue to trend downward (see chart below). The Bank will likely continue the pause in June, but if the May employment numbers continue strong, the Governing Council will indeed warn that they will remain ever vigilant. I do not expect rate cuts this year.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

Vital Spring Housing Market Bodes Well For The Economy

The Canadian Real Estate Association says home sales in April surged 11.3% month-over-month. The Spring rebound was on the heels of smaller back-to-back gains in the prior two months. Now that the Bank of Canada paused interest rate hikes and home prices in most regions have softened, homebuyers are scrambling for the minimal available housing supply.

Following the trend in recent months, the sales increase was broad-based but once again dominated by the B.C. Lower Mainland and the Greater Toronto Area (GTA). Toronto home sales, for example, rose by 27% m/m. That’s the most significant monthly increase over the past two decades, besides the rebound from the 2020 Covid lockdowns.

The benchmark price of a Toronto home rose 2.4% to C$1.11 million in April on a seasonally adjusted basis. The rise erased declines from earlier this year; prices are now up 0.5% year-to-date in the first four months of 2023.

New Listings

Housing inventory is not just low; it is extremely low, although more recent data suggest that new listings rose in the first week of May. The persistent lack of new listings is hurting home affordability.

The number of newly listed homes edged up 1.6% month-over-month in April; however, the bigger picture is that the new supply remains at a 20-year low. The number of new listings hitting the Toronto market trailed far behind the 27% increase in sales at just 2.8%. That helped shrink the supply of houses on the market, which had built up over the past year by 12.3% and left the city’s active-listings-to-sales ratio, a measure of how competitive the market is for buyers, tighter than the historical average.

And Toronto’s housing market isn’t the only one seeing tighter supply and rising prices. Vancouver, long one of the country’s most expensive markets, also saw its benchmark price rise 2.4% last month.

With national sales gains vastly outpacing new listings in April, the sales-to-new listings ratio jumped to 70.2%, up from 64.1% in March. The long-term average for this measure is 55.1%.

There were 3.3 months of inventory on a national basis at the end of April 2023, down half a month from 3.8 months at the end of March. The long-term average for this measure is about five months.

Home Prices

The Aggregate Composite MLS® Home Price Index (HPI) climbed 1.6% month-over-month in April 2023 – a significant increase for a single month. It was also broad-based. A monthly price rise from March to April was observed in most local markets.

The actual (not seasonally adjusted) national average home price was $716,000 in April 2023, down 3.9% from April 2022 but up $103,500 from January 2023, a gain owed to outsized sales rebounds in the GTA and B.C. Lower Mainland.

Bottom Line

A turnaround in the Canadian housing market is in train. While inventory remains extremely low, homes are not only selling but also selling fast. Short-term fixed-rate mortgages are popular with buyers. A significant change from before the Bank of Canada started raising rates.

While the Bank will likely hold rates steady for the remainder of this year, I do not expect Macklem to cut rates before then. All of this depends on inflation. We will get another read on inflation tomorrow.

The fact that labour markets are still strong and housing activity is picking up has got to make the Bank of Canada a wee bit nervous about inflation reaching the 2% target next year.

Another noticeable thing is the continued surge in the Canadian population, thanks to immigration, has worsened the housing shortage. The supply of new housing, especially affordable housing, is inadequate for the rapidly growing population. Moreover, a recent report by the C.D. Howe Institute’s Benjamin Dachis suggests there are major governmental impediments to providing adequate housing.

The Institute recommends:

• Enable the non-political enforcement of municipal housing policies
• Reform the fees on new development
• ease restrictions on building up and out.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres

High Interest Rates Have Not Slowed the Labour Market Sufficiently

The Canadian labour market has done it again, blowing past expectations for the fifth straight month. In April, a whopping 41,400 new jobs were added, more than double what economists predicted. Since February, monthly employment growth has averaged 33,000, following cumulative increases of 219,000 in December 2022 and January 2023.

The employment rate—the share of the population aged 15 and older—held steady at 62.4% for the third consecutive month in April. This is particularly noteworthy given the population grew by more than a million people in 2022 and is slated to snowball this year, thanks to immigration.

However, there is a catch. All the job growth in April was in part-time positions, while full-time jobs decreased by 6,200. But even with this slight hiccup, the labour market is still going strong, which means the Bank of Canada will likely continue its wait-and-see approach, even as we all wonder when the first rate cut will happen.

The jobless rate held steady at a near-record low of 5.0%, unchanged since December 2022. This remained near the record low of 4.9% observed in June and July 2022. Compared with April 2022, the unemployment rate was down 0.3 percentage points in April 2023.

Wage Inflation Remains High

Of great concern to the Bank of Canada, average hourly wages rose by 5.2% on a yearly basis in a further sign of the labour market’s resilience, with wage growth now above the annual rate of inflation, which was 4.3% in March. It is not that wage inflation caused the surge in the Consumer Price Index last year, but continued vigorous wage hikes become impended in wage-price spiralling as higher costs give businesses cover to rate prices.

Bottom Line

The BoC, despite this report, isn’t likely to budge from its current policy stance. As more and more immigrants enter the workforce, the traditional markers of a strong jobs report are evolving. Even though the unemployment rate remains steady at 5%, it may indicate that we’ve hit a new equilibrium point. That’s why this seemingly “surprising” report doesn’t hold the same weight as it would have in the past.

In addition, the BoC can quickly point out the narrowness of sector hiring and the trend of full-time employment declining while part-time jobs rise. After today’s release, the BoC’s decision to stay on the sidelines is a wise move. But it also means that the Bank will not be in a hurry to cut rates this year.

Dr. Sherry Cooper
Chief Economist, Dominion Lending Centres