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Weekly Newsletter

No Pain, No Gain for the Canadian Economy

September 16, 2022

Randall Bartlett,
Senior Director of Canadian Economics

August was a breath of fresh air after what has been a rough ride for the Canadian housing market. Average home prices posted their first monthly advance since February, and the pace of decline in sales slowed sharply. Housing starts also remained elevated. This comes after home prices took a turn for the worse after peaking nationally in February. Sales have fallen even further, quickly returning local housing markets to balanced territory, many of which had been buyer’s markets throughout the pandemic or even before.

So where does Canadian housing go from here? That’s largely up to the Bank of Canada, which shows no sign of relenting on rate hikes anytime soon. After a massive 100 bps increase in July and another 75 bps in September, the subsequent speech by Senior Deputy Governor Carolyn Rogers made clear that “…demand continues to outstrip supply in many parts of the Canadian economy, and short-term inflation expectations remain high. As long as this continues to be the case, there will be upward pressure on prices.” And as long as there’s upward pressure on prices, monetary policy can be expected to remain hawkish. We’re anticipating another 50 bps hike in October, and maybe more by year’s end. 

Consequently, we don’t expect last month’s brief reprieve in the housing market correction to have staying power. While the path of home price declines may not be linear, the risk remains very much tilted to the downside as borrowing costs continue to ratchet up. But this is really only the beginning, as the brunt of higher interest rates is largely being borne by Canadians with variable-rate mortgages. Many fixed-rate mortgage holders haven’t yet begun to feel the squeeze. Housing starts are also expected to follow existing home sales and prices lower, as falling demand hits new home construction with a lag. 

Rising interest rates should continue to slow residential investment in Canada over the next couple of years. In fact, the pullback began in the second quarter of this year, with an annualized decline of nearly 28%. But that’s not the only sector of the Canadian economy feeling the pain of higher borrowing costs. Real durable goods consumption dropped at an annual pace of 12% in the second quarter—the sharpest quarterly decrease since the depths of the pandemic lockdowns in Q2 2020. Other parts of the Canadian economy are holding up better so far, but monetary policy tightening will hamper their growth as well. As a result, we anticipate economic activity to moderate considerably in Canada, leading to a mild recession in the first half of 2023. (See our recent Economic Viewpoint on the topic.)

But there is a silver lining to all this. Slowing domestic demand will gradually reduce inflationary pressures, prompting the Bank of Canada to eventually cut interest rates. We’re of the view that rate cuts will begin around the end of next year. This should help improve housing affordability, which has continued to erode on higher borrowing costs despite falling home prices. It doesn’t mean there won’t be some pain along with way. But as they say, “No pain, no gain.”

Read the full commentary: No Pain, No Gain for the Canadian Economy