On The Bank of Canada’s Latest Thoughts (on the economy and interest rates) Part I

In this blog, Tembo will dig into the BOC’s latest major statement to the media and the public from mid July, to try to understand the Bank’s analysis of the macro-economic situation Canada finds itself in. What the Bank does in the coming months and years will be crucial to how our economy and society fares at this point of our history.

First and foremost, the BOC is very optimistic and confident of medium to long term economic recovery. The Bank sees the worst of COVID behind us. It cites the overall resilience of the economy and the high efficacy of vaccines as key pillars of stability and strength. Despite these positive forces, the BOC still expresses some uncertainty over how ‘smooth’ the recovery will be, the course of the virus, and how international economic, virus, and financial conditions change. They have no crystal ball, and they don’t pretend that they do. The BOC does point to strong U.S. economic growth and stimulus, along with oil prices recovering as key forces which will benefit Canada and uplift economic growth here.

The BOC sees consumption as being the key domestic driver of recovery: “Some of the sectors hit by lockdowns, including retail, restaurant, and other hard-to-distance sectors, are already seeing a rebound, while others, like business and international travel, may take longer to recover.” The BOC makes the important point that there’s still half a million jobs that must be regained for us to return to pre-COVID levels, but also says that many businesses have optimistic plans to return to full capacity soon. The expectation is that we’ll recover those jobs as people continue to engage economic sectors most hit by COVID (restaurants, retail, bars, services, etc.)

The BOC remains confident that the rest of this year and all of 2022 will see strong, consistent, and sustained economic growth. If the BOC is correct, GDP will go up 6% this year, 4.5% next year, and just over 3% in 2023 – marking a healthy period of recovery ahead. Let’s hope they’re correct, we continue with Part II.

Is It Finally Almost Over?

In a recent briefing to the media, Premier Ford had the following message: “Everyone’s worked hard: healthcare folks have worked hard, the people of Ontario… we just can’t go back, we have to go forward. We can’t afford another lockdown. I’m 99 per cent sure we won’t face any more lockdowns, but nothing in this pandemic is 100 per cent. And we will always follow the guidance of the health table.” The province does have a plan to fully re-open, to move away from the step system, and to return to ‘normal’ with some public health measures if appropriate. To get to this point, our vaccination figures would have to reach 80% for one shot, and 75% for full vaccination.

Ontario’s new Chief Medical Officer Dr. Kieran Moore had this to say: “If [we hit vaccination targets] and other key public health and health system indicators continue to remain stable, then the vast majority of public health and work safety measures will be lifted… only a small number of measures will remain in place, including the requirement for passive screening, such as posting a sign, and businesses requiring a safety plan.” In addition, every public health unit must have 70% of its inhabitants fully vaccinated. As of July 22nd, we’ve hit 80.5% of people with one shot, and 65.6% who are fully vaxxed.

Some expect us to reach this ‘step 4’ in mid August, given the 21 day rule, and given vax increase numbers. Dr. Moore has been quoted in the media as saying that until 90% of the population is fully vaxxed, the threat of more transmissible variants won’t go away.

Prepare For a Federal Election Very Soon

The media have been whispering about a snap summer federal election for many months now, and the tempo of these ramblings has been increasing. In addition to the media chatter is a relentless amount of federal announcements in the last few months, investments in transit, money for Montreal, cash for steelmakers in the Sault, progress on re-opening the border – the list goes on. Polling for the federal Liberals has been very reasonable for a long period of time. The federal Tories have consistently polled in and around 30%, a number too low for a chance at a win. The amount of money the feds are spending due to COVID is historically unprecedented. Everyone is getting something. More money for student loans, more cash for seniors, Canada Child Benefit cheques to parents, all of this points to good political omens for the government.

On top of all of the news, polls, and cash, is COVID vaccination rates, which have risen sharply in the last few months. This trend is good news in and of itself, while also easing any potential criticism that a federal election would be opportunistic and dangerous in difficult times. With 155 seats in the House, the Libs only need to pick up 15 seats to win a majority government. The last Ipsos poll from late June had the government with a 10 point lead over the opposition. The Liberals are dominating in seat rich Ontario, performing strongly in Quebec, and also polling very well in BC. Given the low popularity of Alberta’s provincial Conservative government, the Liberals have improved their polling in Alberta. The opposition only have a big polling lead in Saskatchewan and Manitoba.

The Liberals have leads with basically all major voting groups (millennials, seniors, middle aged parents). The trick for the Liberals is how to trigger the election without appearing too greedy. Nanos polling shows that very few Canadians want an election (only a quarter). The federal government’s stimulus measures and COVID response is crunching through the legislative process with the help of the NDP and Bloc abstentions, so there’s no argument over dysfunction. This is not the early Harper era, where an election was always around the corner and the opposition were all eager to pull the trigger. How and when the Libs make their move, no one knows, but a late summer election would give them the momentum.

What happens if they actually raise rates?

The Bank of Canada’s language on rates has tightened dramatically in the last several months. It was not long ago that BOC Governor Maklem was saying that rates would stay ultra low for many years to come – this to support the economy that was battered by COVID-19. His language has changed since re-opening has intensified and since economic activity and inflation have picked up. Now we’re hearing that rates will likely go up in 2022, and we’re all aware of the inflation figures which are close to 4%. The language from the Federal Reserve is even more hawkish, suggesting a hike could come soon given unprecedented U.S. spending and money printing and inflation – albeit tapered with plenty of talk of stimulus, bond buying, REPO market support, etc. Will the BOC raise its rates early, or earlier than the Fed? That’s a big question.

The BOC is increasingly pointing to rate hikes in the second half of 2022, and the Fed, while adamant that rates will only go up in 2023, has few in the market fully convinced, especially if high inflation numbers hold. More and more U.S. banks are releasing reports and warning their clients that the ‘transitory’ nature of inflation is under-reporting the reality of the situation. In other words, it won’t be a blip, but it’ll stay with us longer than we’re being told. In an interview with the Financial Post, CIBC Deputy Chief Economic Benjamin Tal suggested that the BOC and Fed would coordinate a joint rate hike in the second half of 2022, especially if inflation pressures keep up. Tal also made the point that the Canadian government is more vulnerable to a rate hike than the U.S. government, and that private debt in Canada has continued to grow in the last several years even as U.S. consumers slightly paid down their credit cards.

Another striking point made by Tal was that the effect of a rate hike would be more pronounced in Canada today than it would be in the past, given our greater dependence on debt: “Our estimate is that a 1% increase in rates today would be equivalent to a 2% increase ten years ago, so the effectiveness of monetary policy is crucial.” Tal’s worry is that the BOC waits too long to raise rates, or increases them too quickly, suggesting that such a move would be very risky for the market, the economy, and government finances. On a positive note, Tal is bullish on the second half of 2021, agreeing that the economy will see strong growth (some 6%) because of increased consumption and a post-lockdown boom.

Inflation has finally arrived to Canada’s shores

For the last decade Canada has enjoyed inflation that never rose over 3%, hitting the Bank of Canada’s target. There were times when inflation was so low and unalarming that economists and public figures called for massive government spending and even interest rates to stimulate economic growth and employment gains. Now, because of the financial and economic aftershocks of COVID-19, the party is over given the arrival of the latest inflation stats. May saw inflation hit 3.6%, the highest rate in a decade. This is notable because it shows that Canadian inflation is almost as high as the U.S. (3.8%), where multi-trillions have been printed and spent by governing bodies in the wake of COVID-19.

Not since the early to mid 1990s has Canadian inflation approached 4%. This inflation is the result of low interest rates and huge increases in government spending across the board, coupled with supply shortages and labour disruptions. Housing and rental costs increased by 4.2% in May, furniture and appliance costs rose almost 4.5%, and gas prices have surged by over 43% from May 2019 figures. Car prices are going up, health care prices are rising, and some food items are getting more expensive – especially meat. The overall 3.6% inflation was not unexpected, economists expected a 3.5% increase, and Tembo has been writing about the potential for higher inflation and its importance to the real estate market for years.

The big question now is will this inflation remain, will it get worse, or will it begin to dissipate? All eyes are on this. If inflation sustains itself rates will have to go up. Economists are all saying that this inflation is transitory, that it’s a temporary offshoot of COVID, and that it’s a natural bounce from the low point where prices fell in the immediate aftermath of COVID. We’re already seeing that the ‘lumber bubble’ has apparently popped, and that lumber prices will now begin to fall from serious highs – so that could back up the ‘transitory’ argument. But with restrictions lifting, and people eager to consume and spend money, demand for goods and services will only grow. There’s unpredictability out there, but let’s all hope that inflation will go away.

Canada’s Population and Housing Needs Are Soaring

Canada’s 2011 census saw the population tick in at just under 33.5 million, a 6% increase from the 2006 census of 31.6 million. By 2016, the national population had risen to over 35 million people, and Statscan estimates that over 38 million live in Canada as of this year. In just a decade, over 4.5 million more people live in this country, and that has placed huge pressures on housing, employment, and our environment. That’s the net equivalent of adding the population of Toronto, Mississauga, and Brampton to the country. Long term estimates project 46.5 million people living in this country in 20 years. Immigration will continue to increase throughout the 21st century. The bulk of immigrants settle in three regions, already plagued with serious housing supply issues (the GTA, Greater Vancouver, and the Greater Montreal area).

How will we house the many millions that have arrived and that have ambitious housing aspirations, let alone the millions more that are coming? Experts are calling for ambitious, broad public policy measures. The dependence on urban sprawl, and building vast suburban lots of detached housing can’t continue forever. Accessible land is in short supply, and is extremely expensive. Canadian society is far too decentralized, individualistic, and suburban to fully embrace the kind of densification that has been the norm in many societies around the world where populations are large and where land is limited – Hong Kong, Tokyo, London, Manhattan. Experts, however, believe that intensification, redevelopment, and densification are the only ways enough ‘affordable’ housing stock can be brought onto the market to meet growing demand.

If immigration continues to surge, and the Trudeau Government is banking on it to, a detached home will become a luxury with average prices hitting well over $1 million in more and more parts of the country. While Canada is an enormous country, only 4% of its surface area is arable, and 90% of the rapidly growing population lives within a very narrow belt of this land adjacent to the U.S. border. It is estimated that every day, Ontario loses 175 acres of land to development. Population density in southern Ontario is rapidly increasing, and some believe that unless densification proceeds effectively and rapidly, we will have to build homes on protected and designated land to meet demand and consumer choices.

Historic News for GTA Public Transit Will Spur Densification and Higher Home Values

The Federal government has finally taken a strategic leadership role in the construction of public transit in the GTA. Several weeks ago, Ottawa announced that it would cut a cheque for over $12 billion on key strategic transit projects in the GTA. This is the first time in living memory that Ottawa has contributed significant funding (we’re talking about multi billions) to a broad number of public transit projects in the GTA.

In Toronto over $10.4 billion will be allocated to the Ontario Line, the Scarborough Rapid Transit replacement, the Eglinton Crosstown LRT and the Yonge-North subway extension. This funding will cover about 40 percent of each project and guarantees construction will start soon and that provincial and municipal bodies will fully commit themselves to accelerate work. In Hamilton, almost $2 billion in federal money will go toward building the long debated LRT in the downtown core. The federal funding puts to a complete end the debate over an LRT or BRT in Hamilton, which had raged for over a decade. The Hamilton LRT will spur an increase in density and a more cohesive and communal downtown core which is dominated by bus and car traffic.

None of these transit lines will be done soon, tunnelling hasn’t even begun, and given how slow we are at actually building transit, it’s likely these projects will take 10 years to get done. Governments are using 2029 as the completion date for all of the Toronto transit projects. Either way, the projects in Toronto encompass and back up Premier Doug Ford’s GTA transit expansion plan, including the province’s bold Ontario Line, which is said to be the largest subway expansion in Canadian history, as well as the Eglinton Crosstown West LRT, and the Scarborough and Yonge North subway extensions. The Ontario PCs have estimated the cost of those projects at $28.5 billion.

Stay Positive But Be Mindful of Inflation

The latest Canadian inflation figures are out and are the highest in a decade at 3.4%. Similar data release in the U.S. shows inflation rising above 4%. The increase in April set a new pandemic-era high for the third time in as many months and was the highest reading since May 2011, when the consumer price index posted a year-over-year gain of 3.7 per cent. Gasoline prices in April were up 62.5 per cent on a year-over-year basis, the largest annual increase on record as prices at the pumps rebounded from an 11-year low in April 2020. The consensus, for now, is that this inflation is temporary, and that it will subside – but this remains to be seen. If more people start going back to work and if the economy re-opens, that could open up a flood of activity that will exacerbate inflation – we will see.

In response to this, BOC Governor Macklem had the following to say: “There are far too many Canadians unemployed, and that is putting downward pressure on inflation. So, yes, we expect it to go up to around three (per cent) and then diminish thereafter.” But Macklem also warned that rates will have to go up eventually, a big change of tune from a couple of months ago – when the BOC said that low rates would remain for years to come. Here’s what he said on rates: “Interest rates have been very low, and at some point they are going to go back up.” South of the border in the U.S., where money printing has been more intense and inflation spikes more poignant, banks are raising red flags on the long term stability of the U.S. dollar.

At the same time, the BOC is voicing more anxiety over the quality of mortgage debt that has been issued over the pandemic: “The quality of new mortgage borrowing deteriorated during the pandemic. The share of newly issued mortgages with a loan-to-income (LTI) ratio above 450 per cent rose substantially in the second half of 2020.” But at the same time, the BOC is again pointing to the importance of higher real estate prices: “”If house prices and household incomes were to fall in the future because of a shock to the economy, some households could need to cut back on spending. This would slow the economy and possibly put stress on the financial system.”

April Was a Rough Month for the Ontario Job Market – Because of Lockdowns

Employment in Ontario decreased by 152,700 in April, even though employment growth surged in March. The province rightly pointed to tough lockdown measures, new, more contagious variants, and the overall third wave of COVID-19 as the culprit. Despite a tough April, the Ontario economy has already recovered over 850,000 of the 1.1 million jobs COVID cost us, and there are still over 15,000 net new men and women working in the Ontario manufacturing sector from pre-COVID highs. The Province believes that ongoing quickening in the pace of vaccinations will facilitate opening of the economy in the coming weeks. Tuesday marks a big vaccine milestone:

As of 8am on Tuesday, May 18th, Ontario is opening up eligibility for COVID-19 vaccines to everyone aged 18 and older – this a week earlier from older timelines. Those who meet the criteria can begin booking appointments through the province’s online portal and call centre or through their local public health unit, depending on where they live. Ontario expects 2.2 million more doses of vaccines to arrive this week ahead of the Victoria Day long weekend. Among the additional doses is a shipment that was not supposed to land until next week. Over a 100K vaccine doses are being administered a day, with a 150K threshold reached not long ago.

Despite the uptick in vaccinations, Ontario Premier Doug Ford’s popularity is on the rapid decline, due to recent lockdowns and backtracks. Political commentator for The Toronto Star Martin Regg Cohn recently wrote an op-ed suggesting that the Premier is toast, pointing to recent opinion polls: “But his COVID bump in the polls is in the past, Ford’s personal approval ratings are in free fall, and the PCs have tumbled in the party standings, according to recent surveys. The third-place Liberals have reclaimed the lead, vaulting ahead of the Official Opposition NDP. Consider the contrast with his counterparts — Quebec’s François Legault and B.C.’s John Horgan. Quebec bore the brunt of COVID infections and deaths for most of last year, and has imposed controversial evening curfews, yet Legault’s popularity never wavered; British Columbia’s NDP government was a laggard in paid sick days, and also wanted to restrict personal movement, yet never paid a political price.” We will see in a year or so if Ford is finished, but there’s no doubt that fatigue with shutdowns has been building for a long time.

How to Slow Down Price Growth and ‘Normalize’ Momentum

There’s been more and more talk in the media and by real estate experts on the need to implement some rule changes and stringent new measures to the real estate market to slow down the double digit, and record breaking sales and price growth activity we’re seeing. Many believe that the federal government’s budget measures and actions have been symbolic, and that tough changes are being avoided to leave construction and real estate booming to help the overall economy recover.

Rema has some broad suggestions:

“Only by grossly increasing supply in the Canadian housing market to reach the majority of homebuyers, making all purchases conditional on financing to reduce financial overextension of buyers, and implementing regulations concerning listing price thresholds, will we find the answer to cooling the exuberance enveloping Canadian real estate.”

National Bank CEO Louis Vachon thinks a solution could be banning ‘blind bidding’:

“Regulators may need to implement additional tweaks to Canada’s mortgage underwriting criteria and consider new measures. That might include banning blind bidding — the practice of bidding on a property without knowing the value of competing offers — to slow the speed of the home price growth.”

Others have called for a capital gains tax on the sale of primary homes, a political, economic, and socio-cultural sacred cow in Canada. It should be noted that the current Governor of the BOC, Tiff Maklem, when he was number 2 at the BOC, warned in 2013 that real estate was eating up too much capital, investment, and labour, and that there was insufficient investment being made in production and long term growth. Even some senior Top 5 Banking figures are calling on aggressive new measures to cool the market – that’s how dynamic things have gotten.