If NAFTA talks fail or Canada’s inflation runs above acceptable levels, there could be a knock-on effect for the housing market, with a correction possible.

That’s according to the latest outlook from the OECD global policy forum which has updated its outlook to reflect changes since the last report in May.

The outlook for the global economy has been reduced to 3.7% for 2018 and 2018, down 0.1 percentage points, while Canada is expected to grow 2.1% this year (unchanged) and 2% in 2019 (down 0.2 pp).

While the outlook for Canada is essentially strong, driven by exports and a resurgence of the auto and energy sectors, there are still headwinds, especially with high home prices and high levels of household debt.

These include the NAFTA agreement, which if it does not conclude with terms as good or better than the current deal, could stifle growth. A regulatory burden to increasing oil pipeline capacity would also have a negative impact on growth.

Additionally, if inflation rises too high, the Bank of Canada may need to hike interest rates beyond current expectations, which the OECD says could impair the ability of many households to service their mortgages, leading to a housing market correction.

Housing market dangers are “especially acute” in Australia, Hong Kong, Canada and Sweden, Oxford Economics said, noting this has historically posed a threat to economic activity.

“In all four, valuations are very elevated, there has been a lengthy housing boom, debt levels are high and there is a significant share of floating rate debt,” Adam Slater, lead economist at Oxford, said in a research note.

On the positive side, it notes risks are relatively limited in key markets like the U.S., Germany, France, China and Japan. In addition, across most economies there has been no significant recent rise in mortgage rates, which have even fallen in some cases.

“So, the classic ‘trigger’ for house price declines is largely absent,” Slater said. “However, rising rates are not strictly necessary for prices to start falling.”

House prices are falling in Australia, down almost 3 percent in the year through August in major cities, and 5.6 percent in the Sydney market. Meanwhile, three of the nation’s four major banks raised mortgage rates in recent weeks, blaming higher funding costs. The increases came even as the central bank leaves official rates at a record low.

Oxford said it compared markets across OECD countries from 1970 to 2013 and found a clear negative relationship. Where valuations had risen 35 percent or more above the long-term average over that period, real house prices fell 75 percent of the time over the following five years, it said.

“This points to many OECD countries seeing stagnant or negative real house price growth in the next few years: the scope for a further house price ‘melt-up’ in highly valued markets looks extremely limited,” Slater said.

Stretched valuations also matter because house price changes can have a significant impact on economic activity, Oxford said, citing a sample of 83 house price booms. It also found house prices tended to fall after booms, and often substantially.

“For the G7 countries, we find a positive relationship between consumer spending and real house prices from 1997, albeit possibly weakening in recent years,” Slater said.

In a real shocker, Statistics Canada announced this morning that employment dropped by 51,600, retracing most of the 54,100 gain in July. Economists had been expecting a much stronger number, but the Labour Force Survey is notoriously volatile, and job gains continue to average 14,000 per month over the past year. Full-time employment growth has run at about twice the pace at an average monthly increase of 27,000. Labour markets remain very tight across the country.

The unemployment rate returned to its June level of 6.0%, ticking up from 5.8% in July. July’s jobless figure matched a more than four-decade low. At 6.0%, the unemployment rate is 0.2 percentage points below the level one year ago.

All of the job loss last month was in part-time work, down 92,000, while full-time employment rose by 40,400. The strength in full-time jobs is a sign that the labour market is stronger than the headline numbers for August suggest.

On a year-over-year basis, employment grew by 172,000 or 0.9%. Full-time employment increased (+326,000 or +2.2%), while the number of people working part-time declined (-154,000 or -4.3%). Over the same period, total hours worked were up 1.6%.

Statistics Canada commented that monthly shifts in part-time employment could result from movements between part-time and full-time work, the flux of younger and older workers in and out of the labour force, changes in employment in industries where part-time work is relatively common, or deviations from typical seasonal patterns.

By industry, the decline was broadly based and included a loss of 16,400 jobs in construction and 22,100 in the professional services sector. The number of people working in wholesale and retail trade declined by 20,000, driven by Quebec and Ontario.

Job losses were huge in Ontario as employment increased in Alberta and Manitoba. Employment was little changed in the other provinces.

After two consecutive monthly increases, employment in Ontario fell by 80,000 in August, which was the province’s most significant job loss since 2009. All of the decline was in part-time work. On a year-over-year basis, Ontario employment increased by 79,000 (+1.1%). The Ontario unemployment rate rose 0.3 percentage points in August, to 5.7% (see table below).

In Ontario, full-time employment held steady compared with the previous month, with year-over-year gains totalling 172,000 (+3.0%). Part-time jobs fell by 80,000 in August, following a roughly equivalent rise in July. In the 12 months to August, part-time work decreased by 93,000 (-6.7%).
Employment in Alberta rose by 16,000, and the unemployment rate remained at 6.7% as more people participated in the labour market. Compared with August 2017, employment grew by 53,000 (+2.3%), mostly in full-time work.

In Manitoba, employment rose by 2,600, driven by gains in part-time work, and the unemployment rate was 5.8%. On a year-over-year basis, employment in the province was unchanged, while the unemployment rate increased 0.8 percentage points as more people looked for work.

In British Columbia, employment edged up and the unemployment rate increased 0.3 percentage points to 5.3% as more people searched for work. Compared with a year earlier, employment was virtually unchanged.

Wage gains decelerated to their lowest level this year as average hourly earnings were up 2.9% y/y, the slowest pace since December.

There is no real urgency for the Bank of Canada to hike interest rates as the economy shows little risk of overheating. So far in 2018, the economy has shed 14,600 jobs, but the number masks a 97,300 gain in full-time work. Part-time employment is down by 111,900 this year.

The economy is running at or near full-employment as job vacancies continue to mount. If a NAFTA agreement comes to fruition, it is still likely the Bank of Canada will raise interest rates once again at the policy meeting in October. The Bank of Canada guided in that direction yesterday when Senior Deputy Governor Carolyn Wilkins said the central bank’s top officials debated this week whether to accelerate the pace of potential interest rate hikes, before finally choosing to stick to their current “gradual” path.

Canada’s economy is adjusting well to higher borrowing rates and tighter mortgage lending restriction.

That was one of the key messages from the Bank of Canada’s senior deputy governor Carolyn Wilkins in a speech to the Saskatchewan Trade & Export Partnership on Thursday.

She spoke about the BoC’s decision this week to keep interest rates on hold but made it clear that higher rates are coming, albeit in small steps.

Inflation remains the main reason for the rate rise and she reinforced the bank’s assessment that the economy, both domestic and global, is positive.

Ms. Wilkins said that interest rates remain low compared to what would be considered a ‘neutral rate’, which the bank has clarified is in the 2.5-3.5% range.

Economy on target but volatile

The Canadian economy should operate near potential over the next couple of years, she added, but said that the quarterly GDP profile would remain volatile for the rest of 2018.

With a spike in exports in Q2 likely to ease and outages in the oil sector also expected to weigh on growth, Q3 data may be weaker; but the BoC is still expecting growth of around 2%.

She said that recent GDP data supported the bank’s decision to increase rates in July and she noted that household consumption and home renovations data showed that Canadians are generally adjusting well to the higher rates.

Housing market stabilizing

Ms. Wilkins spoke about the housing market, noting that there have been impacts of policy decisions on the resale market.

This has been prominent in the Toronto and Vancouver markets but there are signs of improvement, especially in Toronto, but also other urban areas such as Regina and Saskatoon. Vancouver activity and price growth remain subdued.

Overall though, the signs are that borrowers and mortgage lenders are coping with higher rates and tighter mortgage rules.

There is also an improvement in household credit growth and in the quality of new uninsured mortgages.

In conclusion, Wilkins said: “Recent data reinforce Governing Council’s assessment that higher interest rates will be warranted to achieve the inflation target. We will continue to take a gradual approach, guided by incoming data.”

She added that the BoC will continue to assess the impact of higher rates and how that might be changed by NAFTA and other trade policy developments.

OTTAWA _ The Bank of Canada’s decision to leave its interest rate unchanged Wednesday could be just a brief pause that comes as it carefully follows the unpredictable twists in the country’s trade talks with the United States.

The central bank kept its benchmark at 1.5 per cent, but many experts predict another increase could arrive as early as next month.

In a statement Wednesday, the Bank of Canada said more hikes should be expected thanks to encouraging numbers for business investment, exports and evidence that households are adjusting to pricier borrowing costs.

The bank, however, also made a point of saying it’s closely watching the renegotiation of the North American Free Trade Agreement and other trade policy developments, which could have negative impacts on the Canadian economy. It’s particularly concerned with the potential implications for inflation.

Last week, U.S. President Donald Trump announced he had reached a bilateral trade agreement with Mexico that would replace the three-country NAFTA. He put pressure on Canada to join the U.S.-Mexico deal, but after fresh talks restarted last week Ottawa and Washington have so far been unable to reach an agreement.

Trump notified Congress last Friday of his intention to sign a trade agreement in 90 days with Mexico _ and Canada, if Ottawa decides to join them. If a deal can’t be reached, the president has also repeatedly threatened to impose punishing tariffs on Canadian auto imports.

Frances Donald, senior economist for Manulife Asset Management, said the Bank of Canada’s explicit mention of NAFTA in Wednesday’s statement suggests the negotiations have become even more important around the governing council’s table.

“They’re sending a message that everything looks as planned… What that says to me is that an October rate hike is still certainly in play,” Donald said about the

However, she said the NAFTA reference gives the Bank of Canada options to possibly stay on hold next month, particularly if trade talks _ and the outlooks for the economy and inflation _ deteriorate.

Governor Stephen Poloz, she added, has been “fairly agnostic” on the outlook for NAFTA. She said he’s pointed to potential negatives as well as positives, while the stressing everything is hypothetical until something is decided.

Benjamin Reitzes of BMO Capital Markets wrote in a note to clients that Wednesday’s statement makes it clear the NAFTA talks are biggest issue for markets and the Bank of Canada at the moment.

“There’s big time risk here, but most are still expecting a deal to get done,” Reitzes wrote as he referenced the apparent month-end deadline for NAFTA negotiations.

“Assuming all goes well with NAFTA (perhaps a big assumption) and the data over the next seven weeks, an October rate hike still looks like a reasonable expectation.”

Poloz has raised the rate four times since mid-2017 and his most-recent quarter-point increase came in July. The next rate announcement is scheduled for Oct. 24.

The Bank of Canada said Wednesday that the economy has seen improvements in business investment and exports despite persistent uncertainty about NAFTA and other trade policy developments.

“Recent data reinforce governing council’s assessment that higher interest rates will be warranted to achieve the inflation target,” the bank said as it explained the factors around its rate decision.

“We will continue to take a gradual approach, guided by incoming data. In particular, the bank continues to gauge the economy’s reaction to higher interest rates.”

The statement also pointed to other encouraging signs in Canada, including evidence the real estate market has begun to stabilize as households adjust to higher interest rates and new housing policies. Credit growth has moderated, the household debt-to-income ratio has started to move down and improvements in the job market and wages have helped support consumption, it said.

The bank can raise its overnight rate as a way to keep inflation from running too hot. Its target range for inflation is between one and three per cent.

Heading into Wednesday’s rate decision, analysts widely expected Poloz to hold off on moving the rate _ at least for now.

Last month, Poloz stressed the need to take a gradual approach to rate increases in times of uncertainty. He made the remarks during a panel appearance at the annual meeting of central bankers, academics and economists in Jackson Hole, Wyo.

Improvements in the economy have led to the Bank of Canada’s governor Stephen Poloz vowing to increase interest rates but will September see a hike?

Unlikely, according to two leading economists.

Avery Shenfeld from CIBC Economics says that the BoC will typically announce an increase following strong economic data but that early signs for Q3 do not make a compelling case for a rate rise.

He points out that, while Q2 showed some positive signs, one quarter does not hide an underlying weakness in exports and related capital spending. And inflation is not running away from BoC targets.

Therefore, he expects a hold-steady for interest rates this month, although notes that if NAFTA is agreed then a rate rise won’t be far away.

Over at TD Economics, the expectation is also for Governor Poloz to stand pat this week and to sound a generally positive tone.

“Although the Bank will no doubt continue to emphasize a gradual normalization path with a heavy focus on data dependency, we expect the Bank will be encouraged by economic data over the last six weeks. Notably, the housing market has attained a modicum of stability, while Poloz has consistently stated that the Bank will only incorporate tariffs into their forecast when they are implemented,” the team’s latest report states.

Croft Axsen recently had to inform a client wanting to buy a $300,000 house that he didn’t qualify, so the client instead decided to buy a $95,000 truck. According to Axsen, it is but one example of how easily credit debt can accrue, and how it’s more detrimental to Canadian households than mortgage debt.

“I get it’s easier for the government to regulate mortgage debt, but I’m not sure they’re doing consumers any favours by saying, ‘We’re going to control whether you can buy a house or not, but we’re not going to control whether or not you can buy a $95,000 truck,” said Axsen, owner of Dominion Lending Centres Jencor Mortgage Corporation.

“Instead of buying an appreciating asset, he buys a truck with a bigger payment. By the time the seven-year loan is over, the truck will be worth virtually nothing.”

Canadian mortgage debt has surpassed the trillion dollar mark, and that is worrying the government, but DLC President Gary Mauris says there’s a much bigger problem.

“Unsecured debt is the biggest problem,” he said. “The sheer cost and monthly maintenance of unsecured debt is worrying. Credit card debt, line of credit debt and department store debt are what’s strangling Canadians. Unfortunately, there’s so much pushback from Canadian chartered banks, and it’s such a large business, that the government doesn’t want to take that fight on, so they look at mortgage debt instead. They should be looking at ways to limit unsecured debt, if anything. It’s much higher and much riskier debt, and it’s what we typically see strangling homeowners.”

Mauris can scarcely recall a time when the Canadian housing market endured as much tumult as it is today. He says that, fortunately, lenders and brokers have become creative—and the latter, in particular, have become even more indispensable to the Canadian public—but it’s still bewilderingly difficult to qualify for a mortgage in 2018.

Even more confusing is the fact that tighter mortgage qualification rules merely push homeowners into more expensive financing channels.

“It’s pushing Canadians into more expensive financing like B, where it used to be A,” said Mauris. “You’re making your consumers pay more for mortgage financing. Overall, we’re in a dog fight and it’s become more important than ever before to work with mortgage agents.”

Axsen understands the imperative not to expose mortgage insurers, but he doesn’t understand why ingenuity is an afterthought.

“I get they’re concerned about CMHC being exposed and the danger to the Canadian taxpayer if CMHC ever gets stressed by something with the housing market, but why not come up with a unique product? You can refinance, but the amortization has to be shorter. Or perhaps make it a higher premium on the refinance debt portion, yet still let them use their house to get away from higher credit card debt or lines of credit debt. It seems like the management of debt could have been done in a way that’s better for the consumer and limits the exposure of CMHC and other insurers.”

Credit cards have a higher arrears ratio than mortgages, however, they’re more profitable for banks—and therein lies the rub.

“There are systems in place to control mortgages, so it’s a lot easier than it would be for the government to tell banks how to give someone a consumer loan, a charge card or line of credit,” said Axsen. “They can appear to be these magnanimous, wonderful guys trying to control debt, and being thoughtful about the whole process, but it would be much harder for them to sit bankers down and say, ‘Okay, let’s look at all this other debt and how you’re making decisions to lend it.’”

This morning, Stats Canada released the second quarter GDP figures indicating a sharp rebound in growth to its most robust pace in a year. Real gross domestic product growth accelerated to 2.9% (all figures quoted in annual rates), up sharply from the 1.4% pace in Q1. The Q2 result is only slightly above the Bank of Canada’s 2.8% forecast released in the April Monetary Policy Report, tempering the expectation of a BoC rate hike at next Wednesday’s policy meeting.

First quarter growth had been depressed by a plunge in housing* (see note below), which fell by a whopping 10.5% annual rate in Q1. Investment in housing increased to a modest 1.1% annual rate in the second quarter. Declines in ownership transfer costs continued, but at a more modest pace than in Q1, while new residential construction contracted for the first time since the third quarter of 2016. However, these declines were more than offset by a sharp gain in outlays for renovations.

The strengthening growth in Q2 mainly reflected a surge in exports (+12.3%)–the biggest quarterly gain since 2014–due in part to notable increases in energy products and consumer goods, particularly pharmaceutical products. Exports of aircraft, aircraft engines, and aircraft parts increased sharply on higher shipments of business jets to both the U.S. and non-U.S. countries. Exports of services edged down a bit. Net exports (exports minus imports of goods and services) grew at a 6.5% annual rate in Q2 compared to 4.2% in the prior quarter.

Also boosting growth was stronger consumer spending. Household final consumption expenditure (+2.6%) increased at more than twice the pace of the first quarter, reversing the downward trend over the previous three quarters. Growth was attributable primarily to outlays on services (+3.2%), which outpaced outlays on goods. Housing-related expenses (housing, water, electricity, gas and other fuels), up at a 2.4% annual rate, contributed the most to the widespread growth in consumption of services.

Household spending on goods grew at a 2% annual rate following a flat first quarter, with rebounds in semi-durable and non-durable goods. Purchases of vehicles declined at a 2% annual rate. One negative in the consumption numbers may be that the increased spending was financed by a lower household savings rate. The consumer saving rate fell to 3.4% in Q2 compared to 3.9% in Q1 and 4.5% in the final quarter of last year.

Despite the sharp improvement in growth in Q2, market watchers might be disappointed as slowing business investment brought growth in below the 3.5% forecast of some Bay Street economists. The Canadian dollar dropped in immediate response to the report.

Business investment in non-residential structures, machinery and equipment and computers and computer peripheral equipment decelerated to its slowest pace since the fourth quarter of 2016, which might well have reflected the uncertainty surrounding the renegotiation of NAFTA and the imposition of tariffs on a growing number of Canadian exports to the U.S. Business sentiment and investment in capital formation is an important leading indicator of future growth, so the Q2 slowdown bodes poorly for the outlook. Most analysts are forecasting a marked slowdown in GDP growth in the current quarter to less than 2%.

Interest Rate Outlook

In light of the deceleration in business investment, the Bank of Canada has little reason to hike interest rates at the Bank’s next policy meeting on September 5. Investors are betting that a rate hike in October is a near certainty according to Bloomberg Canada.

Bank of Canada Governor Stephen Poloz played down inflation worries and the prospect of aggressive interest rate increases last week at a Fed conference in the U.S. Poloz argued that the recent spike in inflation to 3% in July, the highest in the G-7, was due to transitory factors that would eventually be reversed. The wage measures in today’s GDP report, along with the separate May employment earnings numbers, point to the Bank of Canada’s ‘wage-common’ measure rising 2.4% in Q2,  little changed from the increase in the first quarter.

Even though Canada is bumping up against capacity constraints and labour shortages are rising, Governor Poloz appears to be in no hurry to bring interest rates all the way back to non-stimulative levels. He has repeatedly made a case for gradualism citing heightened uncertainty over geopolitics and trade as well as economists’ inability to measure critical parameters like potential growth.

The Bank of Canada has raised its benchmark interest rate four times since July 2017 to cool the economy, and market indicators suggest investors are expecting as many as three more hikes over the next year, after which the central bank is anticipated to go into a long pause. That will leave the target for the benchmark rate, currently at 1.5%, at 2.25%–below the 3% “neutral” rate the Bank estimates as a final, non-stimulative resting place for overnight borrowing costs.

• new residential construction;
• renovations; and
• ownership transfer costs.

New residential construction is the most significant component. Renovations to existing residential structures are the second largest element of housing investment. Ownership transfer costs include all costs associated with the transfer of a residential asset from one owner to another. These costs are as follows:

• real estate commissions;
• land transfer taxes;
• legal costs (fees paid to notaries, surveyors, experts, etc.); and
• file review costs (inspection and surveying).